Cracking the Code: Small-Cap ESG Strategies in the Era of the Updated QCA Guidance
At Addidat, we have been reflecting on the updated Quoted Companies Alliance (QCA) Corporate Governance code, released in November 2023, and what it means for the strategy and disclosures required of small-cap companies. There’s been a number of articles which comprehensively summarise the changes per principle (see the image below for an overview), so we won’t spend more time on the wording changes. Instead we have pulled together our guidance on what small-cap leaders and boards need to think about now, not only to ensure corporate strategy and disclosures are aligned with the code as it comes into effect, but to maximise practical business benefit from responding to these changes. Essentially, ESG, the Addidat way!
The revised code will apply for financial years beginning on or after 1 April 2024, with initial disclosures against the revised code expected to be published in 2025.
A summary of the updated QCA governance code principles
1. Consider the expectation to sharply define corporate purpose as an opportunity
Throughout the code, the concept of “purpose” is positioned front and centre to achieving medium to long-term value for shareholders. This is most obvious in Principle 1, which has been amended to clarify that firms must “Establish a purpose, strategy and business model which promote long-term value for shareholders.”
Purpose is defined in the code as a business’s “essential reason for being.” Positioned another way, a question we ask our clients a lot at the start of their ESG journey with us “if your business didn’t exist, what would be the impact to the world?”
At Addidat, this concept of purpose is crucial to how we work with clients to scope and define their ESG strategy. The scope of what can be considered within a sustainability strategy is vast. To be successful, small-caps need to ensure they are right-sizing their ESG activity and that this activity underpins and supports the business strategy. Without this symbiosis, companies risk, at best, being distracted from value delivery and at worst, underdelivering against their ESG commitments – which carries the associated spectres of stakeholder disenfranchisement or perceptions of greenwashing or social washing.
For companies at the start of their sustainability journey, or those wanting to review and refocus with these revised QCA principles in mind, start with corporate purpose and define the organisation’s ESG vision from there. Create focused and authentic goals, crucial to the delivery of Principles 4 and 5 (more on this later).
2. Board composition remains in the spotlight – expect to disclose more around board diversity as 2025 approaches
The guidance around board composition in the 2018 QCA code has been brought forward into Principle 6 “Establish and maintain the board as a well-functioning, balanced team led by the chair.” This new iteration of the code contains more guidance around indicators of independence and explicit encouragement for boards to review their own levels of diversity, balancing skillset and knowledge with the need to avoid groupthink.
Characteristics such as “socio-economic backgrounds, nationality, educational attainment, gender, ethnicity and age” need to be a part of regular assessments of board diversity. Today our data shows that only a handful of AIM-quoted companies are disclosing board statistics on any of these characteristics, other than gender.
Small-caps should be prepared to disclose more broadly in the coming years and ensure statements made around individual independence and committee independence are thorough and clear. As an example, today many firms use “non-executive” as synonymous with “independent” - language which is inaccurate, or potentially misleading to stakeholders.
3. Environmental and Social disclosures are non negotiables. Appropriately integrate ESG now for long-term success
Principle 4 explicitly stresses that small-caps must consider the environmental and social issues material to their business in corporate strategy and their business models; “Take into account wider stakeholder interests, including social and environmental responsibilities, and their implications for long-term success."
Principle 5 reiterates this, indicating that environmental and social risks and opportunities must be integrated into risk management practices with a focus on climate risk, which is no surprise given current TCFD regulations.
As we have already touched on, this starts with setting a purpose driven ESG vision, laser-focused on what is material to the company in question. But we would also encourage leaders to think now on how to most effectively integrate sustainability concerns into core processes.
The means of doing this will differ by company. For example, our data shows that 12% of AIM quoted firms have chosen to form an ESG committee at board level, 14% a non-board level ESG committee and 10% have linked CEO remuneration to ESG factors. This latter statistic is incidentally a figure we will be monitoring closely as we expect this practice to go up over the next two years in line with the updated code implementation.
For small-caps, we strongly believe that one size does not fit all to effectively embed ESG into an organisation. It is more important that leaders assess the outcomes needed to apply Principles 5 and 6, namely that:
There is clear responsibility and accountability for managing ESG risks and opportunities.
There is effective oversight of ESG activity and management is held to account.
There is an ability to track ESG progress and have a grasp on material and pending tasks.
The board and leadership can demonstrate the right level of education and experience on ESG to the rest of the company and other stakeholders.
4. Culture and Employee Welfare – be prepared to get specific with the intangibles
We have been beating this drum for some time now (any excuse to refer you back to our article on what you can learn about employee engagement from The Traitors), but the revisions to the code put particular emphasis on the workforce and the provisions businesses are taking to solicit feedback, create avenues to raise concerns, and ensure employees are treated in line with the values of the organisation.
Leaders need to describe in more detail the nature of corporate culture, how it is monitored and what steps are taken if the organisation deviates from it. More woolly mentions of the word “culture” without the disclosures around values and practices that back this up will not meet the expected disclosures for Principles 2 and 4.
Some examples from our data indicate that there is work to do for small-caps. Clarity of disclosures need to be improved, with our data telling us that currently 56% of AIM quoted companies disclose whistleblowing arrangements. We suspect this figure is higher in reality, but businesses are failing to disclose their arrangements clearly.
Organisations also need to mature their strategies around employee engagement (41% undertake an employee survey today) and make clearer the work being done to align treatment of employees with values (e.g. only 5% disclose employee retention rates today).
Note that although we have focused on employees as a stakeholder here, the QCA are clear that the scope of Principle 4 applies to engagement and feedback from all stakeholders. Who is responsible and how this engagement is managed should be displayed on the company website.
In conclusion
The emphasis in the new QCA code on sharpening corporate purpose, enhancing board diversity, focusing on employee engagement, and integrating environmental and social considerations across business delivery presents both an opportunity to refocus and further disclosure considerations for small-caps.
The message from the QCA is clear. Understanding and addressing material environmental and social factors is core to building resilient, adaptive, and purpose-driven organisations that thrive in today’s environment to deliver long-term value.
Addidat is a QCA code verified organisation. Purchase the full QCA code from the QCA’s website.
To discuss further, please get in touch with the team.
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