Navigating ESG Reporting Challenges for Indian SMEs

The Securities and Exchange Board of India (SEBI) has mandated that all listed companies in India make ESG disclosures for their value chain, which must include both upstream and downstream partners and contribute at least 75% of their revenues (by value).

The onus of disclosure resting on the listed entity, value chain partners would be required to provide some of the data for the ESG disclosures, either through reporting of some key ESG metrics, supplier audits or third party certifications. The fallout being that any noncompliance by the value chain partners, would result in loss of business with suppliers, it is now imperative for value chain partners to adopt ESG as a business norm.
A similar situation arises when startups and SMEs seek external equity or debt capital or even bank financing. Pushed by their reporting obligations and ESG strategy, banks, venture capital firms, private equity firms, family offices, and financial institutions are requesting ESG data from their portfolio companies. In such cases too, any non-compliance by SMEs run the risk of their investment proposals being rejected by these institutions.
The SEBI mandate has raised concerns among listed companies as the stringent norms will trickle down to thousands of ancillary companies and third parties. India has around 63 million MSMEs contributing about 29% to the GDP while 600 large companies add approximately 48% (as per Forbes – February 2024) and implementing ESG reporting could throw up a number of challenges for these companies.

1. Awareness and understanding – ESG is a new idea and defining the scope of ESG factors relevant to a particular industry or sector can be complex. While environmental data allow businesses to assess their ecological footprint, social data includes metrics such as employee diversity, labour practices, community engagement and product safety. In addition, the governance data assesses the internal structure and practices of a company. An SME owner may lack the skill and knowledge to understand, collect and share the relevant data.

2. Resource and Cost Constraints - A business model incorporating all the environmental, social and governance factors involves short term financial pain for long term gain. Most SMEs have limited financial resources for investment, and their priority would be immediate business and financial concerns rather than long term ESG strategy. The initial investments in data collection, reporting systems, process changes, employee training, and potential upgrades to operations could create a financial dent, and operating on tight budgets, it would be difficult for SMEs to prioritise sustainability initiatives amidst competing financial demands.

3. Lack of data – ESG reporting requires Quantitative data which is numerical and directly related to a company`s Key Performance Indicators and Qualitative data which is more observational and experience-based. Setting up robust data collection processes is complex and expensive for SMEs, and sometimes the process may be further complicated by the possibility of the data not being there at all. As ESG data is rarely tracked by the SMEs, data capture and accuracy can be a struggle for these companies.

4. Regulatory Framework

The ESG framework is still in its infancy in India and the absence of standardized ESG reporting frameworks increases the challenges for SMEs.

SEBI's Consultation Paper

With a view to easing the financial and administrative strain on small suppliers dealing with publicly traded businesses, SEBI released a consultation paper in May 2024, on ESG reporting for listed entities, including MSMEs that aims to ease compliance. 

• Disclosures were mandated only for those value chain partners (downstream and upstream) who accounted for 2% or more of the listed company’s purchase or sales by value.
  Environmental disclosures need confirmation on a number of topics, including waste management, water waste, consumption and treatment, and greenhouse gas emissions. Specifically for manufacturing organizations, this entails gathering ESG-related data at every stage of the purchase order and selling process.
  The changes in the paper would not only address concerns over the cost burden on smaller players but also allow them the time needed to set up processes and data systems to report and verify disclosures.

• Renaming ‘reasonable assurance” of ESG data to “reasonable assessment” of ESG data
  The “reasonable assurance” qualification entails a qualified third-party assurance provider reviewing a company's Business Responsibility and Sustainability Reporting (BRSR) disclosures, and this would also require an audit of the value chain partners' disclosures.
  This change would remove the burden of conducting audits by listed companies on the value chain partners, thus reducing the administrative burden and cost of compliance. 

The Indian government is also aware of the challenges that would be faced by the SMEs and hence they are not currently mandated to comply with full ESG reporting under the BRSR framework. The SEBI is gradually phasing in compliance for the top listed companies, with full compliance expected by 2026-2027, meaning SMEs may face increasing pressure to adopt ESG practices in the coming years to remain competitive and attract investors.

To conclude, ESG reporting can be a valuable tool for SMEs to mitigate credit risk and improve access to finance, by reporting accurate and transparent information specific to their business operation. This would provide lenders with valuable insights into a company`s environmental, social and governance practices enabling them to assess long term risks thus influencing credit risk decisions and reducing their credit risk.