The impact of sustainability reporting on the SME supply chain

Accountants will play a critical role in helping SMEs manage the impact of new sustainability reporting requirements on their supply chains. Niamh Brennan, Louise Gorman and Seán O’Reilly explain why

The EU’s Corporate Sustainability Reporting Directive (CSRD) was transposed into Irish law in July 2024. Those in management and accounting functions in some of Ireland’s large companies have struggled to interpret the Directive’s requirements. 

The legislation will require reports under European Sustainability Reporting Standards (ESRS) from 1 January 2025 for the 2024 financial reporting year. 

In recent years, many large companies have voluntarily reported sustainability information under the Global Reporting Initiative (GRI) and the Taskforce for Climate-related Financial Disclosures (TCFD) frameworks. 

Moreover, the environmental topics covered by the ESRS are derived from the EU Green Taxonomy, with which large entities in certain sectors have already reported alignment. This alignment prepares them for the CSRD requirements to some extent. 
Listed SMEs will not come within the scope of the CSRD until 2027 (for the 2026 financial year), with an opt-out for two further years to 2029 (for the 2028 financial year). 

Nonetheless, many SMEs, both listed and unlisted, will experience the effects of sustainability reporting requirements before these dates.

Significance of the value chain

The ESRS require disclosures on material environmental, social and governance topics. Such disclosures must detail the undertakings’ own operations as well as those throughout their value chain. 

The value chain refers to the full range of activities, resources and relationships related to the undertakings’ business model and the external environment in which they operate. 

In Ireland, many large companies’ activities, resources and relationships involve SMEs. Examples include financial services institutions with SME customers, and food and beverage producers with SME suppliers. 

The implication of such relationships, in ESRS terms, is that large companies must gather sustainability information from SME value chain partners.

Reporting challenges for SMEs 

We have conducted two research studies on sustainability reporting for Irish SMEs. Our first study employed the GRI framework, and our second used the EU Green Taxonomy, to assess SMEs’ reporting preparedness. 

Mindful of SMEs’ strong reliance on their Chartered Accountants for reporting and advisory needs, we engaged with professional Irish accounting practitioners to gain insights into the challenges they face. 

Both studies were conducted in 2022 in anticipation of the publication of the ESRS by the European Financial Reporting Advisory Group (EFRAG). Our findings are highly relevant now that sustainability reporting is legally mandated.

The findings of both studies indicate that cost is the greatest barrier encountered by SMEs. 

In particular, set-up costs, ongoing data management expenses and potential operational changes, are likely to prevent the average SME from collecting and reporting accurate and reliable sustainability data. 

Resources, particularly human resources and associated training costs, also pose a substantial impediment to implementing a sustainability reporting system. Related to this, both studies identify a significant sustainability knowledge gap within SMEs. 

While an implicit understanding of the importance of environmental and social sustainability exists, many SME managers and employees have not received education on the necessary topics or metrics which must be disclosed, many of which are scientific or highly specialist in nature.
 
Finally, access to the necessary technology to manage and report sustainability information is limited. Appropriate data management and reporting systems have only recently become available, at a price point that typically only large companies can currently afford. 

With these issues in mind, future problems are envisaged as large undertakings request sustainability data from SME customers and suppliers for ESRS reporting.

Supports for SMEs

Supports could help to alleviate the challenges facing SMEs over the coming years. Our research found that national or EU governmental grants, tax incentives or carbon credits may assist SMEs in overcoming cost-related challenges. 

The accounting practitioners in our studies also recognised that education and training in sustainability reporting for SME management and relevant employees may need to be subsidised. 

Beyond financial supports, participants in our study indicated that simplified disclosure requirements would be appropriate for SMEs. 

Since we reported these opinions from our study, EFRAG has published an exposure draft of Voluntary SME (VSME) sustainability reporting standards for small non-listed enterprises. 

The exposure draft presents a modular approach that SMEs can adopt on a phased basis. 

Alongside simplified reporting requirements, another non-financial support deemed suitable by our respondents was the establishment of a state-sponsored or equivalent body to provide SMEs with consultancy, resources and tools for sustainability reporting. 

The Department of Enterprise Trade and Employment’s recently established National Enterprise Hub represents a valuable opportunity to aid Irish SMEs in meeting sustainability data demands from larger companies.

The path ahead for SMEs

In the immediate term, large undertakings collecting sustainability data from smaller value chain parties can avail of transitional provisions when data is not available in the first two to three years of reporting. 

Nonetheless, such reliefs are limited amidst a strong impetus across Europe to set and achieve Greenhouse Gas emissions’ reduction targets in line with the Paris Agreement. 

Without data from value chain parties, measures of Scope 3 emissions reported by large undertakings under the climate change standard, ESRS E1 Climate Change, will be inaccurate and misleading. 

At a time when greenwashing is considered almost akin to financial fraud by the general public, large undertakings may impose pressures on small enterprises to produce relevant measurements, even if regulators do not. 

Failure to do so may cost SMEs valuable business relationships. Disclosures required under ESRS E4 Biodiversity and Ecosystems will also impact Irish SMEs in value chains in sectors such as agri-food. With the Circular Economy Act signed into Irish law in 2022, reporting on the circular economy under ESRS E5 Resource Use and Circular Economy may be deemed a material topic for many companies. 

ESRS E5 requires extensive discloses on product lifecycles and may well also necessitate data collection from SME suppliers as well as from SME consumers. 

In fact, it is important not to consider SMEs solely from a supplier perspective. In terms of social sustainability, ESRS S4 Consumers and End-Users sets out reporting requirements on consumers’ use of goods and services, with a particular emphasis on health and safety. 

SMEs intermediating between large companies and end-consumers will also be required to report upstream to larger companies in value chains. 

Additionally, ESRS S2 Workers in the Value Chain requires large undertakings to report on the composition of suppliers’ and customers’ workforces, as well as their working conditions.

Sources of support

Our research findings, coupled with an analysis of the ESRS requirements, clearly indicate that support for SMEs is vital to ensure they retain strong positions within value chains in Ireland and across the EU. 

Prompt development of the VSME standards is essential. Without standardisation, SMEs face requests from multiple supply chain stakeholders to provide various types of data in different formats. 

The introduction of the VSME standards in a manner that encompasses guidance to larger firms on best practice in data collection from smaller value chain partners may ease the reporting challenges for undertakings of all sizes. 

The role the accounting profession will play is integral, as smaller entities will need sustainability reporting alongside traditional accounting services. 

Chartered Accountants Ireland offers advice, education and representation for members in the area of sustainability reporting. 

As these requirements becomes a priority for SMEs, the Institute will continue to provide support to Chartered Accountants navigating the nuances of this major development in accounting and reporting.

Niamh Brennan is Michael MacCormac Professor of Management at University College Dublin
Louise Gorman is Assistant Professor at Trinity College Dublin 
Seán O’Reilly is Assistant Professor at University College Dublin