1. Introduction
Diversity and inclusion (D&I) is now a key concept in UK financial services, with D&I requirements stemming from several different regulatory angles. In this note we will explore some of the recent regulatory initiatives around D&I, but before we look at recent activity, it’s worth taking a moment to examine the requirements already in existence.
UK banks and investment firms, for example, must meet the requirements on the diversity of their board, which are contained in Chapter 6 of the General Organisational Requirements Part of the PRA Rulebook and SYSC 4.3.A9R to 4.3A.11R of the FCA Handbook. These types of firm are required to engage a broad set of qualities and competences when recruiting members of the board and are therefore required to put in place a policy promoting diversity of the board. Firms with nominations committees are also required to set a gender target on the board and prepare a policy that enables the target to be met. Beyond these provisions, we see D&I requirements emerging from a number of areas. For example:
- The joint guidelines from the European Securities and Markets Authority and European Banking Authority on the assessment of the suitability of members of the board and key function holders under the Capital Requirements Directive (CRD) IV and Markets in Financial Instruments Directive II (MiFID II) require that diversity should be taken into account when selecting and assessing members of the board.
- For banks and insurance firms, as part of the implementation of the CRD V, the FCA introduced requirements for affected firms to have gender neutral remuneration policies and practices. These were transposed into the FCA’s dual-regulated firms’ remuneration code in December 2020 and included references to the UK Equality Act 2010.
- The EU Investment Firms Directive provides for gender balanced remuneration committees and MiFID II firms that are not small and non-interconnected to report gender pay gaps.
- PRA Supervisory Statement 5/16, which generally applies to PRA-regulated firms, provides that for boards to be effective they need to include individuals with a diverse mix of skills and experience.
- The Financial Reporting Council’s Corporate Code, which applies on a ‘comply or explain’ basis, contains certain requirements for firms with a premium listing in the UK including that the annual evaluation of the board should consider composition, diversity and how effectively members work together.
2. Recent regulatory initiatives
There have been a number of FCA speeches on D&I, most notably by the FCA’s CEO Nikhil Rathi in March 2021, on why diversity and inclusion are regulatory issues.
The speech from Mr Rathi pointed out that the lack of diversity at the top raises questions about firms’ ability to understand the different communities they serve, and their different needs. He also mentioned that he would question if a firm can adequately respond to the needs of its consumers if it did not have the diverse background required to overcome biases. He also pointed to research that had suggested that greater gender diversity improves risk management culture and decreased the frequency of misconduct fines.
Among the statistics quoted in the speech was one stating that fewer than 1 in 10 management roles in financial services were held by black, Asian or minority ethnic people. Also, environmental, social and governance issues are rising to the top of the agenda for corporates, investors and wider society. All of which has compelled regulators into action.
Following the speech three important papers setting out the regulators’ plans for D&I were published in July 2021:
- FCA Business Plan.
- Joint Discussion Paper between the FCA, PRA and the Bank of England on D&I (DP21/2).
- FCA Consultation Paper on D&I on company boards and executive committees (CP21/24).
3. The FCA Business Plan
The FCA Business Plan stated that the FCA wanted to improve D&I in financial services to ensure high standards of conduct and behaviour.
In the Business Plan the FCA set out the following core outcomes that it wanted to see:
- Regulated firms and listed companies to have more diverse representation at all levels.
- Regulated firms and listed companies to foster cultures that are inclusive so that staff can share their diverse experiences and backgrounds.
- Firms design and deliver products that reflect the diverse needs of consumers, offer fair value and are delivered in a fair and accessible way.
4. DP21/2
To start moving firms towards achieving these outcomes, the FCA together with the PRA and Bank of England published DP21/2 in July 2021.
It’s worth noting that DP21/2 is relevant to all regulated firms, including payment services and e-money firms, credit rating agencies and financial market infrastructure firms (FMIs). It’s also worth noting, however, that in some places DP21/2 is quite light on detail.
The regulators recognise that D&I will be different for different firms and will not apply a one size fits all approach. There is some discussion regarding proportionality in DP21/2 with the FCA mentioning, for example, that for solo regulated firms subject to the Senior Managers and Certification Regime the existing firm categorisation of Enhanced, Core and Limited Scope might be used. Also for overseas firms operating in the UK the regulators are keen to get views on how its D&I proposals could work given that governance and culture are often influenced outside the UK.
In relation to what diversity actually is, the regulators’ focus on something called ‘diversity of thought’ or ‘cognitive diversity’ which is about recognising how different perspectives, abilities and attitudes inform an approach to solving problems. The regulators provide a suggested definition of diversity of thought, which concerns bringing together different perspectives, attitudes and abilities, all of which can be influenced by many factors including those characteristics that are visible (for example, gender, age and ethnicity) or non-visible (for example, disability, sexual orientation and education). The characteristics are not limited to the nine protected characteristics defined in the Equality Act 2010 (i.e. age, disability, gender reassignment, marriage and civil partnership, pregnancy and maternity, race, religion or belief, sex and sexual orientation) and they can also include other factors, such as socio-economic diversity, gender and cultural background.
5. Inclusion
The regulators view inclusion as the practice or policy of providing equal access to opportunities and resources for people which might otherwise be excluded or marginalised. In practice, it means that views and contributions should be valued and fully considered regardless of any differences due to demographic characteristics or background. The FCA refers to a growing body of evidence that diversity of thought, when part of an inclusive culture, supports better decision making by firms. It believes that more diverse and inclusive firms benefit from better risk management, as individuals feel more empowered to have open discussions and debates, without fear of having their views shut down.
From a retail perspective, the FCA believes that firms need to be sufficiently diverse and inclusive to be able to understand and meet the needs of their diverse customer bases; otherwise their customers are at a greater risk of harm.
6. Data – the 2021 survey
One of the policy options being considered in DP21/2 is regular reporting of diversity data to the regulators. The regulators feel that the pace of change in relation to D&I has been too slow and they want data to be able to measure progress and change but also identify areas for intervention and set targets.
To move things forward DP21/2 spoke of the regulators conducting a one-off voluntary pilot data survey in the autumn of 2021 which was intended to inform any future proposals on potential reporting requirements.
The pilot survey, which did take place last autumn, had three objectives, to understand the levels of diversity within firms in order to inform future policy developments, to understand what categories of data firms currently collect on D&I in relation to staff, and to understand firms' strategies and plans to collect D&I data in the future.
DP21/2 also stated that a future proposal for data collection may cover the following:
- Membership of the board and the executive committees.
- Demographic diversity of the board and senior managers (as mentioned above, the regulators will use demographic and socio-economic diversity to represent diversity of thought).
- Demographic diversity of the workforce.
- Whether there are any internal diversity targets for the board and senior managers, and firms' progress.
- High level firm-wide data on demographic diversity characteristics and inclusion practices.
If the data proposals are implemented firms will need to build systems and collect data from employees where they are not already doing so.
7. The tone from the top
DP21/2 covers a number of policy options concerning the so-called tone from the top. This covers, among other things, board representation, with diversity being a key consideration in board recruitment strategy. This includes considering whether the requirements that currently apply to significant banks, investment firms and some FMIs should also apply to a wider range of firms.
The regulators have also asked for views on the merits of setting any requirements or expectations for firms to set recruitment targets for under-represented groups.
The regulators also mention the possibility of requirements similar to those introduced last year in the US by NASDAQ. These being requirements on NASDAQ listed firms to publicly disclose diversity statistics regarding their boards and, in addition, having a rule applicable to most NASDAQ firms requiring them to have, or explain why they do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBT.
As for individual accountability, the regulators feel that making senior leaders directly accountable for D&I in their firms would be the most effective way to increase the rate of change. For dual regulated firms, the regulators are looking at two ways to do this. First, most dual regulated firms have to allocate prescribed responsibilities (
PRs) set out in the PRA Rulebook, and two of these PRs, (I) and (H)
1 relate to a firm’s culture and the regulators are thinking about clarifying that these PRs encompass responsibility for the implementation and execution of a firm’s D&I policy. Second, for dual regulated firms that do not have PRs for culture, the regulators are considering whether responsibility for D&I could be covered in a Senior Manager’s Statement of Responsibilities. For solo regulated firms, there is no PR for culture. The FCA wants to explore whether it can expressly allocate responsibility for D&I policies to senior managers.
In terms of remuneration, variable remuneration awards for material risk takers (individuals who can materially affect the risk profile of the firm) is presently based on financial and non-financial performance, and the regulators have queried whether they should develop guidance on how metrics linked to D&I can be used as part of the non-financial criteria.
8. Firm wide policies and practices
In DP21/2 the regulators also looked at firm-wide policies and practices, including seeking views on a requirement for all firms to have a D&I policy, which the regulators believe will form the foundation of a D&I strategy, and to publish it on their website.
The regulators say that they don’t want to be prescriptive about the content of the D&I policy but on the other hand also state that it should include the foundations such as clear objectives, realistic goals, a plan for meeting those goals and ways of measuring progress.
The regulators also propose a consistent definition of “senior management” for the diversity policy and for large firms this will include the board and the two leadership layers below the board. By having a consistent definition the thinking is that it will support benchmarking between peers.
As mentioned earlier, the regulators are seeking views on the merits of setting regulatory requirements or expectations for firms to have targets for their boards. They are also keen to hear views on whether targets should be set for customer-facing roles (especially certified staff). Furthermore, DP21/2 also seeks views on the role and value of D&I training, including whether it should be voluntary or mandatory.
Whilst noting the FCA guidance on vulnerable customers and the new Consumer Duty, the FCA also asks the question whether it should develop rules or guidance on product governance that specifically take into account a customer’s D&I characteristics.
9. Regulatory measures
In terms of regulatory measures, the regulators’ focus on three broad issues: fitness and propriety, senior management function (SMF) approval and threshold conditions.
a) Fitness and propriety
For fitness and propriety, it’s worth noting in DP21/2 that the regulators refer to instances in the past where the FCA has found an individual not to be fit and proper on the basis of non-financial misconduct. The regulators ask whether guidance should be developed as to what constitutes non-financial misconduct, which may include evidence of sexual harassment, bullying and discrimination on the basis of someone's protected (or otherwise) characteristics as factors to take into account.
The regulators also raise the possibility of firms needing to assess whether evidence of such behaviour constitutes a breach of the conduct rules which would need to be disclosed in future regulatory references. They also mention developing guidance on how such behaviour could result in a breach of the conduct rules.
b) SMF approval
As for SMF approval the regulators are considering whether to collect diversity data about an individual as part of the information provided for SMF applications. In addition, where the regulators have concerns that a proposed appointment would worsen or not address risks arising from a lack of diversity and group think, they are considering whether this could provide grounds for withholding approval.
c) Threshold conditions
As for the threshold conditions the regulators are considering developing additional guidance on how they may take into account the firm's record on D&I in assessing whether the firm meets the threshold conditions. It might cover, for example, how the PRA and FCA could take into account board and senior management diversity in assessing whether the firm has appropriate non-financial resources and also how non-financial misconduct by individuals connected with the firm may influence the regulators' assessment of suitability.
10. CP21/24
In CP21/24 the FCA sets out proposals to amend the Listing Rules (LRs) and the Disclosure Guidance and Transparency Rules (DTRs) in relation to diversity on boards and executive committees. The FCA mentions that when implemented the proposals will provide increased transparency and better data on diversity. This will allow the FCA to better assess what further steps it can take to promote greater diversity on company boards.
The FCA’s proposals in CP21/24 include requiring in-scope companies
2 to include a statement in their annual financial reports setting out whether they have met diversity targets, to publish diversity data on the composition of their board and senior executive team, and the issuance of new guidance to assist in-scope firms with what other diversity information they may want to publish.
Specifically in regards to gender diversity, CP21/24 indicates that the Hampton Alexander review target of women making up 33% of FTSE 350 boards by the end of 2020 has been met, and so a new target of 40% is proposed to build on this and add new momentum. The Parker Review target that each FTSE 100 board should have at least one director from an ethnic minority background by 2021 and for each FTSE 250 board by 2024 has not been met, and so proposals have been issued to require firms to meet this target.
Current
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FCA Proposals
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Most FTSE 350 companies currently provide data under the Hampton Alexander review on FTSE women leaders and the Parker review on ethnic diversity of UK boards.
The Hampton Alexander review set a target of women making up 33% of FTSE 350 boards by the end of 2020. The Parker review provided that each FTSE 100 board should have at least one director from an ethnic minority background by 2021 and for each FTSE 250 board to do the same by 2024.
In March 2021, 81 FTSE 100 companies reported that they had appointed a director from an ethnic minority group, showing there is still time to act to meet the 'One by 2021' target. |
New LR 9.8.6R(9) and LR 14.3.27R(1): in-scope companies to include a statement in their annual financial reports setting out whether they have met the following targets as at a chosen reference date within the accounting period: at least 40% of the board are women (including individuals self-identifying as women); at least one senior board member (chair, CEO, SID or CFO) is a woman; and at least one board member is from a non-White ethnic minority background (as categorised by the ONS). Where companies have not met the targets, they must explain why.
New LR 9.8.6R(10) and LR 14.3.27R(2): in-scope companies to publish, in a standard format, data on the gender and ethnic diversity of their boards, senior board positions and most senior executive management. It also seeks views on whether in future it should require data on sexual orientation, and extend reporting to one level below executive-level.
New guidance at LR 9.8.6GG and 14.3.29G: in-scope companies may wish to include in their annual financial reports: a brief summary of any key policies, procedures and processes, and any wider context, that they consider contributes to improving the diversity of its board and executive management; any mitigating factors or circumstances which make achieving diversity more challenging; any risks they foresee in meeting the targets in the next accounting period; and any plans to improve board diversity.
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CP21/24 also proposes changes to DTR 7.2.8AR and the disclosure of a firm’s D&I policy.
Current
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FCA Proposals
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DTR 7.2.8AR currently requires an issuer's corporate governance statement to contain a description of the diversity policy applied to the issuer's administrative, management and supervisory bodies with regard to aspects such as, for instance, age, gender or educational and professional backgrounds. The existing DTR also requires the issuer to outline the objectives of the diversity policy, how the policy has been implemented and the results in the reporting period. Where no such policy is applied, the issuer must explain why this is the case.
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Amend DTR 7.2.8AR to indicate that a company's disclosure on its diversity policy should also include the diversity policy applied to its remuneration, audit and nominations committees; and also cover aspects such as ethnicity, sexual orientation, disability and socio-economic background. It also proposes adding guidance at DTR 7.2.8CG that companies may include numerical data on the diversity of the board and committees in their description of the results in the reporting period (DTR 7.2.8AR(1)(d)).
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If finalised the amendments would apply to accounting periods starting on or after 1 January 2022 which means that companies would first make the additional disclosures in annual financial reports published for that year in spring 2023. However, the FCA is also encouraging companies to consider making disclosures on a voluntary basis in annual financial reports published before then.
11. Next steps
In terms of next steps we were expecting more detailed proposals in Q1 this year (although this may now be H1 this year) which will then be followed by a Policy Statement in Q3/Q4 2022. In the meantime, in DP21/2 the regulators warned that firms can expect supervisors to ask a lot more questions about D&I.
