This article first appeared in Forum, The Edge Malaysia Weekly on August 12, 2024 - August 18, 2024

Melting ice shelves, rising sea levels, record-breaking heat waves — these are powerful images that constantly remind us of the importance of preserving the environment. As the effects of climate change grow more severe each year, so do concerns about a country’s ability to adapt and the calls for stronger policies to deter environmentally unsustainable behaviours. Malaysia is no exception to this global trend, and it is a development we cannot afford to fall behind on. The adoption of sustainable principles is crucial not only for preserving the environment but also for remaining relevant and competitive in an increasingly conscientious market.

One of the brighter spots in Malaysia’s sustainability journey is its relatively low vulnerability and high readiness to adapt to climate change. While the country has faced its share of climate change-induced challenges, it is considered relatively resilient. According to the Notre Dame Global Adaptation Initiative, Malaysia ranks 12th among upper-middle-income economies and 49th among 185 countries in overall vulnerability.

In terms of readiness, which measures the country’s ability to leverage investments and convert them into adaptation actions, Malaysia is ranked 10th among upper-middle-income countries and 54th globally. This readiness indicates a capacity to integrate and benefit from environmental, social and governance (ESG) practices, provided the right strategies and support mechanisms are in place.

However, the main challenge for Malaysia will be to ensure that businesses, particularly small and medium enterprises (SMEs), are prepared to cope with this transition as economies worldwide begin enacting policies to encourage sustainable business practices through taxation and operational compliance.

A critical risk for Malaysian SMEs is losing access to export markets, which are increasingly prioritising sustainability. This could become a significant non-tariff barrier, especially for the smaller and more vulnerable SMEs. According to a September 2023 survey by the Small and Medium Enterprises Association of Malaysia, less than 12% of Malaysian SMEs are ready for ESG implementation, despite over two-thirds recognising its importance. In a world where ESG practices have shifted from being a luxury to a necessity, low readiness among SMEs puts them at a disadvantage and could hurt their global competitiveness. SMEs that fail to comply with ESG practices risk losing business opportunities, finding it harder to attract investors and missing out on sustainability-related tax incentives.

Adding to these challenges is the looming issue of carbon taxes, which are increasingly being implemented worldwide. So far this year, around 75 compliance carbon-pricing instruments are in place globally, more than double the number from a decade ago. Of these, 39 are carbon taxes and 36 emissions trading systems.

For Malaysian SMEs, the introduction of a carbon tax could pose a significant challenge. The risk of double taxation, where SMEs might face both local and international carbon taxes, could increase operational costs and impact competitiveness. However, if managed well, this could also drive innovation and efficiency in operations, nudging business behaviour in the right direction.

If businesses recognise the immense value that ESG practices bring, what is stopping firms, especially SMEs, from adopting them?

A survey conducted by RAM Rating Services in mid-2023 found that the barriers to ESG progress are more pronounced among smaller SMEs and micro-firms. A lack of incentives was the most common hurdle, cited by 45% of firms surveyed. Additionally, 40% of respondents said it was too expensive to adopt green practices. However, over half of the firms, particularly those with multinational clients, are keen to adopt sustainability initiatives to become ESG-compliant.

The good news is that these challenges have not gone unnoticed. The Malaysian government, through agencies like the Malaysian Investment Development Authority (Mida) and SME Corporation Malaysia, has introduced various forms of assistance to encourage ESG adoption. These include tax incentives, ESG readiness tools and comprehensive assessments to guide SMEs on their sustainability journey. Mida also recently launched the Domestic Investment Accelerator Fund), a matching grant to help SMEs and mid-tier companies transition to ESG practices. This support structure provides a solid foundation for SMEs to build upon.

That said, there is still room for improvement in the adoption of ESG practices. One potential gap is in awareness and education. Many SMEs may lack the knowledge of how to implement these practices effectively or where to obtain government assistance. ESG reporting and compliance can also be resource- and human capital-intensive. There is a pressing need for capacity building and skill development within SMEs.

A collaborative effort between the government, private sector and non-governmental organisations is crucial to create a supportive ecosystem for ESG compliance and bridging the knowledge and resource gaps. This proactive approach will ensure that Malaysian SMEs remain competitive, relevant and contribute positively to a sustainable future.

Woon Khai Jhek, CFA is a senior economist and head of the economic research department at RAM Rating Services Bhd

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