When discussing issues such as sustainable development and ESG performance management, the current focus is mainly on large enterprises and financial institutions (FIs), while very little attention is paid to small and medium-sized enterprises (SMEs). However, SMEs, as part of their value chains, are integral to the ESG management of large ones. For example, in certain industries, the environmental impact of the supply chain activities far exceeds that of their own operations. One study found that the indirect greenhouse gas (GHG) emissions by the investment and financing activities of FIs are 700 times more than the emissions from their own operations. Against the backdrop of increasingly stringent sustainability information disclosure requirements, the ESG management of large enterprises and FIs necessitates the participation of SMEs. At the same time, the emergence of sustainability barriers in international trade also requires foreign-related enterprises to strengthen cooperation with upstream enterprises in their value chain to jointly promote sustainable development.
From a macro perspective, SMEs play an indispensable role in the green low-carbon transition and inclusive development due to their large numbers and the jobs they create. For instance, in the industrial sector, which is the key to achieving the 30/60 goals, SMEs constitute the overwhelming majority in terms of numbers. However, they usually are featured by relatively backward technology, poor energy efficiency, and high pollution and emissions. This presents another challenge for the industrial sector to achieve green and low-carbon development. Additionally, in the process of transforming high carbon-emission industries, many jobs will be affected, with SMEs bearing the brunt. To smoothly advance the 30/60 goals and ensure a just transition, SMEs should receive due attention.
Furthermore, SMEs, as major players in innovation, can provide innovative solutions for sustainable development. For instance, to achieve carbon neutrality, the energy system needs to promote technological innovations in areas such as end-use electrification, low-carbon hydrogen, and bioenergy. SMEs have unique advantages in driving science and technology innovation due to their agility, faster decision-making, focus on specific niches or technology selection, risk appetite, and proximity to market demands and users.
However, factors such as inadequate capabilities and awareness, high costs of green low-carbon transition, and lack of financial support hinder SMEs from fully participating in sustainable development. For instance, a survey conducted last year by the Chinese Academy of Financial Inclusion (CAFI) found that the vast majority of surveyed micro and small enterprises (MSEs) expressed a willingness to take practical actions to reduce carbon emissions in their business activities, but over 60% of them did not know how to measure greenhouse gas emissions. Additionally, many surveys have found that a lack of sufficient funding is a major constraint that prevents SMEs from taking climate action.
In the area of green technological innovation, a survey found that many startups actively engaged in green technology face significant challenges in financing. They reported that, first, financing channels such as green credit and green bonds are primarily directed towards more established companies; second, equity investment is hard to obtain.
Sustainable finance in China has already reached a considerable scale, with green credit balances exceeding 30 trillion yuan. So why do SMEs report difficulties in obtaining green loans? By analyzing 140,000 loan records from a county-level city in an eastern province, we found that SMEs may face several types of “green exclusion”.
First, standards exclusion. Currently, FIs mainly refer to the relevant Green Industry Catalogue to identify loans directed towards green investments. However, the Green Industry Catalogue is primarily designed to guide funds towards industries that are most crucial for promoting green development. Therefore, it has not yet covered many industries where SMEs are prevalent. Additionally, in line with international practice, the Green Taxonomy typically prioritizes industries, projects, or activities with significant environmental benefits. As a result, those projects or activities with less obvious environmental benefits or those that are currently difficult to be assessed are excluded from the Green Taxonomy for the moment. Consequently, some SMEs find the standards for green loans "unfriendly". In addition, since the standards for transition finance are in progress, the transition needs of many SMEs have not yet been fully met.
Second, data exclusion. The lack of credit information has long been one of the main factors preventing FIs from financing SMEs. With the advancement of digital technology and lending techniques, FIs have made significant progress in overcoming issues related to the lack of credit information. However, banks now face new data challenges when offering green loans to SMEs. Banks need to ensure that the green loans they issue are indeed directed towards projects or activities recognized by the Green Industry Catalogue. However, it is quite challenging for SMEs to provide supporting documentation, which hinders them from obtaining green loans.
Third, product exclusion. Currently, the sustainability-linked loans offered by banks are primarily project loans directed towards green investments. However, there is still a lack of relevant ESG products in working capital loans and supply chain loans, which are more relevant for the financing needs of SMEs.
Lastly, incentive exclusion. At present, green finance is mainly policy-driven. Banks find it easier to meet regulatory requirements by providing green financial services to large-scale enterprises and projects; whereas the incentives for banks to offer green financial services to SMEs are lacking.
What’s more, green technology startups might not need green loans. From the perspective of the business lifecycle, the business models of startups have not yet been validated, so they have high risks, so they don’t check the boxes of bank lending. However, a prominent structural issue in China's sustainable finance market is the low proportion of direct financing, with green credit accounting for 86% of the total sustainable finance market.
Moreover, some issues in the equity investment sector also undermine the support for green technology startups. First, in recent years, China’s equity investment has seen continuous market clearing, resulting in an overall reduction of the amount of institutions and capital. Second, the equity investment sector has undergone structural changes, with the financiers shifting from predominantly market-driven to policy-driven. Due to this change in funding sources, investment strategies have also shifted from pursuing financial returns to achieving functional indicators such as local industrial transformation and promoting local economic development. Given that policy-driven funds are typically featured by large scale, short cycle, and low fault and risk tolerance, investment preferences have systematically shifted towards companies with mature business models and low risks. This may conflict with the status and needs of many startups in the green and low-carbon technology sectors, resulting in a lack of financing channels for early-stage startups that are not yet commercially viable. Third, due to the requirements of funding terms and its investment principles, the policy-driven funds may not be able to play a catalytic role, but instead cause a “crowding out effect” on social capital. Fourth, the increasingly stringent requirements for listing have made it more difficult for private equity (PE) to exit, further reducing capital flow, raising the threshold for obtaining commercial returns from equity investments, and diminishing the willingness of limited partners of equity investment funds to contribute. As a result, more and more equity investment funds tend to invest only in IPO-ready mature companies, systematically neglecting the financing needs of startups that have great potential but are in an earlier development stage. Fifth, the current structure of funding sources shows a clear clustering effect, leading to homogenized investment strategies, narrow investment directions and preferences, “herd investing” and extreme valuations, while small-scale diversified investment is decreasing.
Sixth, throughout the life cycle of green tech enterprises, not only is it extremely difficult to obtain equity investment at the earliest stages due to the high risks, but they also face a lack of financing channels when transitioning from prototype validation to pre-mass production.
It is evident that the limited sustainable investment and financing for SMEs are caused by some issues on the supply side of sustainable finance that are yet to be addressed. The public sector can play a role in addressing these issues. For instance, based on international experience, policy-based FIs can directly provide sustainable loans, sustainability bonds, and equity investments to SMEs. Additionally, the public sector can play a guiding role by mobilizing social capital to provide sustainable financial services to SMEs through government financing guarantees, government guidance funds, and monetary policy incentives. Furthermore, on the demand side, tax and fiscal policies, capacity-building supports, and a favorable development environment can encourage SMEs to participate more in sustainable development.
However, from the perspective of policy-makers, we believe there are a few core questions that need to be answered. First, in the field of sustainable development, should differentiated policies be introduced specifically for SMEs? For example, in terms of sustainability information disclosure, should the disclosure burden on SMEs be reduced by establishing simplified disclosures? Second, how can the issue of missing ESG data of SMEs be addressed while balancing the roles of the government and the market? Third, how can we fully leverage the catalytic and mobilizing role of public capital? Fourth, how can we address some structural issues in sustainable finance? For example, the proportion of direct financing is too low, and direct financing is overly concentrated on the public sector. Fifth, the issue of capacity building for FIs. We do not have definitive answers to these questions, but we hope that by highlighting these issues, we can provide some food for thought.
Regarding how to leverage the catalytic and mobilizing role of public capital, we believe the key lies in clarifying the role of public capital. Whether it is government financing guarantees or government guidance funds, the fundamental mission of public capital is to guide commercial capital into areas with significant social benefits but high financial risks and unclear returns by sharing the risks. Conversely, if preferential financing guarantees are provided to enterprises that can easily obtain bank loans, or if government guidance funds invest in enterprises that are also the targets of market-driven capital, then the public capital not only fails to play its catalytic and mobilizing role but may also create a “crowding out effect”. If the risk tolerance of public capital is lower than that of commercial capital, it may run counter to its original mission. It is evident that public capital needs to bear some of the risks from which commercial capital usually refrains. In practice, a common international approach is to put the public capital at a lower ranking fund/inferior fund/at the posterior position of the capital structure of the funds jointly financed by different types of capital. However, there are concerns over issues like moral hazard, public capital might bear unnecessary losses. This concern is valid, which is why it is essential to assess the social benefits generated by the use of public capital. Especially, we need to adopt scientific, objective, and quantitative evaluation methods to ensure that public capital will not drift from its original mission.
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