Diversity and inclusion in financial services regulators take step to codify firms obligations

Top 5 actions for firms

If recent events are anything to go by, the need for focus on diversity and inclusion within society has never been starker.  So it should come as no surprise that in financial services, the regulators have taken their first step in what is likely to be the road to new and positive requirements on diversity and inclusion for regulated firms.  In a joint discussion paper 21/2 ("DP21/2") which was published on 7 July 2021 the FCA, the PRA and the BoE (together the "regulators") make a credible case as to why diversity and inclusion matters in financial services, both in terms of who is running financial services firms and how financial services firms need to better reflect the customers they are serving. 

The initial output of the discussion paper will be a voluntary data reporting exercise that will be launched in Autumn this year by the regulators who will seek to collect data from a sample of solo regulated firms, all dual regulated firms and a selection of FMI firms.  The next steps which are likely to be more medium to long term are to look at the various policy levers available to the regulators and use those to explore the introduction of new rules and regulations that will be designed to put diversity and inclusion at the heart of financial services firms' corporate governance and product design.

This note sets out a high level summary of what those proposals may look like and what actions firms would be well advised to take now. 

Regulators' view of diversity and inclusion

Recent regulatory communications have focused on diversity and inclusion within financial services firms but the publication of DP21/2 is the starting gun to the formalisation of these requirements.  In DP21/2 the regulators note that "diversity and inclusion are critical to [their] work on culture and governance, particularly for boards and senior management. […] We expect to see diversity and inclusion become part of how we regulate and part of how the UK financial sector does business. For the Bank of England and the PRA, the key consideration is about the linkage between insufficient diversity and inclusion and groupthink, which can present a serious risk to safety and soundness. Our goal is to see increased diversity and inclusion in financial services translate into safer and sounder firms with better internal governance and risk management, a more innovative industry, and financial products and services that meet the diverse needs of consumers.”

The FCA links these proposals in DP21/2 to its recent focus on vulnerable customers and its proposals around the new Consumer Duty (which we looked at in our briefing here). 

The regulators define diversity as a focus on diversity of thought which is about “bringing together a range of different styles of thinking among members of a group. Factors that could lead to diverse thinking could include, but not limited, to different perspectives, abilities, knowledge, attitudes, information styles, and demographic characteristics, or any combination of these.” The regulators go on to note that diversity of thought is affected by a number of characteristics such as gender, age and ethnicity (being visible characteristics) or disability, sexual orientation and education (non-visible).  The regulators' approach to inclusion is about the practice or policy of providing equal access to opportunities and resources for people who might otherwise be excluded or marginalised for example due to demographic characteristics.  The regulators want to see an industry where all individuals can participate fully, including being able to speak freely without fear. 

Key policy proposals 

The paper states that any future policy proposals would cover all firms that are regulated including payment services firms, credit ratings agencies and recognised investment exchanges.  Some level of proportionality could be applied, whereby diversity and inclusion is encouraged in a way that is appropriate to a firm’s size and complexity and avoids imposing rules that would not be effective or appropriate for smaller firms. 

1. Pilot data survey

The paper set out plans to launch a one off, voluntary pilot data survey in autumn 2021 that will seek to understand:

• the levels of diversity within firms in order to inform future policy developments;
• the categories of data firms currently collect on diversity and inclusion; and
• firms’ strategies and plans to collect diversity and inclusion data in the future, including potential challenges and barriers faced.  

This exercise will inform the development of any future regular data collection obligations.  The regulators state that they hope firms can create an atmosphere where staff can feel free to be open to disclosing information about their background and that future data collection would consist of staff completing a questionnaire. Depending on the output of the pilot data survey, more detailed proposals on potential reporting requirements will be developed and consulted on in due course. The initial aims for regular future data collection would likely cover: the membership of the board, and the executive committees; demographic diversity of the board and senior managers; demographic diversity of the workforce; whether there are any internal diversity targets for the board and senior managers, and firms’ progress; and high level firm wide data on demographic diversity characteristics and inclusion practices. 

ACTION: Firms should be prepared to provide a response to the pilot data survey if required and should be aware of what data, if any, is currently collected by the firm on diversity characteristics and inclusion criteria. 

2. Leaders and governance 

The regulators note the role played by leaders in setting a strategy and helping to deliver cultural change at all levels. The regulators make it clear that they consider that diversity and inclusion should be a concern for leaders at all levels of firms. Boards are expected monitor and challenge progress on diversity and inclusion within firms and diversity and inclusion should figure in conversations about the firm's purpose.  

The paper also considers that risks to the safety and soundness of a firm can be minimised and boards better able to understand diverse consumer groups if oversight of the diversity and inclusion strategy is provided by a board with diversity of experience and thought. The regulators consider that this should be a key consideration in the firm's recruitment strategy.  

ACTION: Firms should look at how D&I features at board level including whether there are agenda items on D&I initiatives, as well as how recruitment practices reflect the firm's approach to D&I. 

3. Individual accountability and SMCR

The regulators consider that senior leaders should be directly accountable for diversity and inclusion in their firms and that this would be additional and complementary to the collective responsibility of the board.  According to the regulators, SM&CR could play an important role in this regard. In relation to dual -regulated firms, the PRA's two prescribed responsibilities concerning a firm's culture are viewed as a starting point in relation to accountability for diversity and inclusion: responsibility for leading the development of the firm’s culture by the governing body as a whole (often sitting with the chair of the board); and responsibility for overseeing the adoption of the firm’s culture in the day to day management of the firm (often sitting with the CEO). The regulators argue that setting out actions in senior managers’ statements of responsibilities could support this. Where firms do not have these Prescribed Responsibilities for culture, the paper suggests that these responsibilities could be dealt with in the appropriate senior managers’ statement of responsibilities. The senior manager would be expected to deliver results, be transparent about success and failure, and focus on the barriers inhibiting diversity and inclusion progress. Good data and ongoing monitoring, including through internal audit would also be necessary to be able to show that these responsibilities are being met. 

ACTION: Firms should revisit their management responsibilities map and senior manager statement of responsibilities to consider whether D&I should feature more prominently, particularly with reference to specific D&I policy initiatives within the firm.

4. Remuneration

The paper notes how linking progress on diversity and inclusion to remuneration could be a key tool for driving accountability in firms. It notes an increasing tendency for firms to link diversity and inclusion to the personal objectives of senior management and through a collective objective for the firm or business unit. The paper seeks views on creating guidance setting out how metrics linked to advancing diversity and inclusion could be used as part of non financial criteria for the purposes of variable remuneration awards (with poor performance in this area as possible grounds for adjustment). The aim would be to provide insight on good practice at the individual and firm level. To implement this, firms would need to have a framework in place to monitor and evaluate progress. The paper suggests including an explicit rule that a firm’s remuneration policy should ensure that all types of remuneration, both fixed and variable, do not give rise to discriminatory practices.   The paper suggests that remuneration committees could have oversight in relation into firms' approach to tackling obstacles that give rise to pay gaps and other adverse diversity and inclusion outcomes. Where firms do not have a remuneration committee, the board would continue to have such relevant responsibility.

ACTION: Firms should consider their current remuneration framework and identify where, if at all, it interacts with any D&I initiatives within the firm.  This is likely to be an area which needs to be revisited if new rules are implemented. 

5. Firms' diversity and inclusion policies

The paper states that a diversity and inclusion policy should be a central consideration for all firms, as it forms the foundation of a strategy and action plan. The regulators are considering requiring all firms to have a policy and to publish it on their website. The regulators do not intend to be prescriptive about the content and note the importance of proportionality. However, the idea would be for all policies to have clear objectives, realistic goals, a plan for achieving these goals and ways for measuring progress. As a minimum, policies would promote diversity of the board. Firms that are smaller in size/with fewer employees and governance structures would be expected to have simpler policies.

ACTION: Firms should consider introducing a D&I policy if they do not already have one.  For firms with existing D&I policies, this should be reviewed in light of potential requirements to publish it on a firm's website. 

6. Other proposals

a. Developing diverse talent for the future - The paper seeks views on setting requirements or expectations for firms to set targets for underrepresented groups for entry into the wider senior management population as well as for customer facing roles. 

b. Training - The paper considers merits of voluntary training versus mandatory training and states that training should not be seen as a "tick box" exercise and should be targeted at an appropriate level and to be followed up. 

c. Products and services that meet the needs of real customers - The paper argues that where the diverse needs of current and potential customers are not considered, this can result in harm and poor consumer outcomes. The paper refers to existing product governance requirements and in relation to treating customers fairly. It also refers to the FCA's recently issued  consultation to introduce a new Consumer Duty (CP21/13). Firms are not expected to design products and services that meet the needs of all consumers but are expected to ensure that their target market is not defined in a way that results in unlawful discrimination under the Equality Act 2010. This is one to watch alongside the new Consumer Duty proposals. 

d. Disclosure - The paper sets out plans to require firms to publicly disclose a selection of aggregated diversity data on the firm’s senior management population and the employee population as a whole, as well as their diversity and inclusion policies. This is likely to be informed by the pilot data survey. 

e. Regulatory measures: fitness and propriety - The paper explores the idea that adverse findings in relation to individuals’ conduct with respect to diversity and inclusion issues could affect the fitness and propriety assessment. It notes instances where the FCA has found an individual not to be fit and proper on the basis of their "non financial misconduct" and suggests developing guidance on this topic to include evidence of sexual harassment, bullying and discrimination on the basis of someone’s protected (or otherwise) characteristics as factors to consider. Firms would need to consider whether evidence of such behaviour amounts to a breach of the Conduct Rules and this would need to be disclosed in future regulatory references. The paper states that regulators could develop guidance on how such behaviour, or failure to take reasonable steps to address this kind of behaviour, could result in a breach of the Conduct Rules. 

f. Threshold Conditions - Pursuant to FSMA, firms must meet a set of Threshold Conditions at authorisation and on an ongoing basis and the paper explores the possibility of developing additional guidance on how a firm’s record on diversity and inclusion would be taken into account when assessing whether the firm meets Threshold Conditions. 

NEXT STEPS

The paper is still at discussion stage only but we fully expect new rules to be introduced as a result of it.  For firms, this is an area which should be scrutinised carefully and be set for future change.