The Prudential Regulation Authority (PRA), Bank of England (BoE) and the Financial Conduct Authority (FCA) (together, the “Regulators”) published a joint Discussion Paper (DP) on 7 July 2021 in which they seek to engage with UK regulated financial entities and other stakeholders to discuss how the pace of meaningful change on diversity and inclusion (D&I) in the UK financial sector can be accelerated.
The DP explicitly recognises the correlation between D&I and positive outcomes in risk management, good conduct, healthy working cultures and innovation and that improving D&I reflects the Regulators’ objectives and their public sector equality duty. The DP also details the actions the Regulators have taken to improve D&I within their own organisations. Whilst recognising the limited progress on D&I that has been made in the financial services sector more generally, the DP acknowledges and affirms that much more needs to be done (in particular at Board and senior management levels) to create truly diverse and inclusive organisations which reflect their clients’ needs. To this effect, the DP is intended to begin a discussion with UK regulated financial entities and other stakeholders to clarify the Regulators’ expectations and to set higher standards in respect of D&I, and the DP recognises that policy has an essential part to play in driving change.In this briefing note, Michelle Chance (Partner) and Chris Warwick-Evans (Associate) explain how it is clear from the DP that the Regulators are strongly committed to increasing the importance they place on D&I in the UK financial sector, what some of the future policy initiatives may look like and why they are of the strong view that in-scope firms should consider participating in the consultation, and what firms should be doing now.
In the DP the Regulators make it clear that they expect to see D&I become part of how they regulate and part of how the UK financial sector does business. However, the Regulators are keen to ensure that any new regime is proportionate and reflects a firm’s size and complexity, and does not seek to impose a one size fits all approach.
Diversity and Inclusion
The DP uses the concept of “diversity of thought” (or “cognitive diversity”) when considering what the Regulators mean by diversity, which the Regulators consider to be important to further their regulatory objectives (for example by helping to avoid “groupthink”).
The Regulators define diversity of thought as the bringing together of a range of different styles of thinking among members of a group. Diversity of thought can be influenced by many factors including demographic factors, socio-economic factors and cultural background, and where individuals have intersectional factors or characteristics (for example, where class and gender together result in interdependent disadvantage). As such, it is important to note that the Regulators regard diversity as far wider in scope than simply the nine protected characteristics (such as race and age) which are recognised as warranting specific legal protections under the Equality Act 2010. Given that many financial services firms have often put the emphasis of their D&I work on trying to ensure the fairer representation of women and ethnic minorities in particular, they will in future need to think about diversity more broadly which may require a change in approach and emphasis.
The Regulators adopt a similarly broad concept of what they regard as “inclusion” and define this as everyone feeling involved, valued, respected and treated fairly such that they have equal access to opportunities and resources, and that these factors are meaningfully embedded in a firm’s culture. They also note that a culture of staff having “psychological safety” (being able to share ideas and speak freely without fear) is important to foster inclusion within an organisation, and aligns to their wider aim of ensuring staff speak up not only when there is potential wrong doing at a financial services firm, but generally to encourage diversity of thought and to avoid “groupthink” which can lead to excessive and reckless risk taking.
A Data Driven Approach
The Regulators recognise the importance of accurate and comprehensive data collection to improve their understanding of D&I and that of the firms they regulate and to enable them to accurately monitor progress in this area. As such, the Regulators want improved data collection by firms and their future proposals for regular data collection is likely to cover D&I information in respect of recruitment, retention, advancement, representation and pay. Amongst other steps, data collection is likely to involve firms approaching staff to complete a diversity questionnaire. However, depending on the specific requirements introduced, comprehensive data collection by firms may be a real challenge, for example given that in practice some staff are often reticent to provide their employer with personal and special category (i.e. sensitive personal) data about themselves even on an anonymous basis, though the Regulators suggest that open dialogue with staff may help overcome this. Data protection and privacy issues will also need to be addressed as the proposals are developed.
Potential Policy Options
The DP outlines various different policy options which the Regulators think could be helpful to accelerate progress in respect of D&I in UK regulated firms where it is proportionate and appropriate to do so, and the key potential initiatives are summarised below. These generally build on existing requirements and expectations and the Regulators’ wider policy and supervisory frameworks.
- The Tone from the Top
- Leadership: The Regulators recognise that improvements will only deliver real change when embedded in culture. Leaders need to set a compelling strategy and empower their teams to develop and implement initiatives that deliver cultural change at all levels within their institution. This will involve the setting of goals and monitoring the effectiveness of change programmes, the identification of barriers to progress and making changes where necessary.
- Governance: Boards will be expected to hold management to account for promoting D&I and the Board will be the appropriate body for setting the D&I strategy and policy and overseeing its progress. Targets could be considered by firms to help achieve representative Boards. Careful Board succession planning could be used to support firms in driving better D&I outcomes.
- Individual accountability: Making senior leaders directly accountable for D&I in their firms (including through the Senior Managers and Certification Regime, as we turn to later below) could be used to drive strategic thinking and relevant discussions among the key decision makers. This would help empower individuals from across the firm to embed D&I into the entirety of a firm’s practices.
- Remuneration: Linking progress on D&I metrics to remuneration could be a key tool for driving accountability in firms and incentivising progress.
- Firm wide Policies and Practices
- D&I Policy: A D&I policy should be a central consideration for all firms, as it forms the foundations of a strategy and action plan. Clearly documented policies help set out expectations for all staff on what D&I means within their organisation, what their respective roles are in fostering an open and inclusive environment and empowering their colleagues to speak up and express their views. The Regulators want to explore a requirement for all firms to have a D&I policy and publish it on their website, and as a minimum for the policy to promote diversity on the Board. However, given that most regulated firms will already have some form of D&I policy in place and given the lack of recent significant progress on D&I, in our view, D&I policies alone will be insufficient and the key for employers will be to link these to effective cultural change with buy-in from senior leaders who model the values and change that they wish to see throughout their organisations.
- Progressing diverse representation: To achieve diverse representation at senior management and Board level, the Regulators believe that firms need to think more about the progression of their employees from their time of entry to the top of the organisation. This will involve considering recruitment, promotion and succession planning (as above) to ensure that diverse employees are progressed. A lack of Board level experience often blocks diverse talent from progressing to C-suite positions. Progressive financial services firms may wish to have shadow boards in which a pipeline of C-suite level talent can be nurtured and mentored and are effectively given board level work experience until they are experienced enough to succeed the current Board members.
- Setting Targets: Consider targets for under represented groups for senior management, customer facing roles and the firm as a whole. In our view, targets will only work if a firm’s culture is sufficiently inclusive that diverse talent remains in the organisation long-term after they are recruited. Otherwise, setting targets will only have short-term impact.
- Training: Implement meaningful D&I training which is pitched at an appropriate level.
- Products and Services: Ensure that products and services meet diverse customer needs, including those of vulnerable customers.
- Disclosure: Require firms to publicly disclose their diversity data on the firm’s senior manager population and employee population as a whole, as well as their D&I policies so that other firms and stakeholders can benchmark progress. This is also relevant to ethical investors, many of whom are choosing to only invest in businesses which reflect their own D&I values. Disclosures could include data on pay gaps going beyond gender to include other characteristics (such as potentially ethnicity for example, though the Regulators’ view on this is unclear at this time).
- D&I Audits: Consider internal D&I audits as these can play a key role in starting to improve D&I in the workplace.
Senior Managers and Certification Regime
As above, the Regulators are also suggesting reforms to the Senior Managers and Certification Regime (SMCR) to secure meaningful progress on D&I in the financial sector and some of the key proposals are set out below.
The Regulators suggest that adverse findings in relation to individuals’ conduct with respect to D&I issues (i.e. non-financial misconduct) could affect their assessment in the future as to whether a person is “fit and proper” to carry out their role and the DP states that the Regulators could develop guidance on this topic to include evidence of sexual harassment, bullying and discrimination on the basis of someone’s protected (or otherwise) characteristics as relevant factors to take into account. It is likely that guidance in this area would be welcomed by many firms as to the requirement to consider such behaviour when making an assessment as to whether a person is “fit and proper” to carry out their role and how this should be reflected in any regulatory reference.
The Regulators also suggest considering whether to collect diversity data about the individual as part of the information provided for Senior Management Function applications so they can understand how firms have considered the proposed appointment and how it will contribute (or otherwise) to diversity in a way that supports the collective suitability of the Board and senior management. Where the Regulators have concerns that a proposed appointment would worsen or not address risks arising from a lack of diversity and “groupthink” the Regulators would look to scrutinise applications further and discuss this with firms. The DP states that this would help the Regulators consider whether this could provide grounds for withholding approval.
Threshold Conditions
The Regulators view that 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 (the minimum requirements a firm needs to meet to carry on regulated activities) could help prevent bad actors from entering the market and act as an added incentive for firms to address significant failings.
Next Steps
The DP is open for comments until 30 September 2021. In our view, UK regulated firms should strongly consider providing responses to the DP to help shape and influence the likely reforms whilst the new proposals are at a formative stage, so they are practicable and effective and not unduly onerous on regulated firms.
The comments and data received will be used to develop detailed proposals, and a joint consultation by the FCA and PRA is planned for Q1 2022, followed by a FCA/PRA Policy Statement in Q3 2022. Separately, on 28 July 2021 the FCA launched a consultation on proposals to improve transparency for investors on the diversity of listed company boards and their executive management teams.
Regulated firms and listed companies should already be collecting and analysing their staff diversity data (subject to UK data protection laws) to understand the profile of their own workforce and how any problems they identify with staff recruitment, retention and progression of under-represented groups can be lawfully resolved without resulting in discrimination claims by other employees. They should also be regularly reviewing and revising their D&I policies, training and practices, and ensuring these are fit for purpose at this stage is likely to make adopting future changes easier to implement, and reduce the risk of successful discrimination claims going forward.
Rosenblatt can help
We regularly advise employers on all employment law and employee relations aspects related to D&I, including staff data collection, advice on recruitment, retention and promotion policies, use of minority staff forums and mentoring programmes, and D&I policies, staff D&I training and embedding cultural change. We also advise regulated firms on their responses to consultations run by regulatory bodies to ensure their views are communicated clearly and consistently for maximum impact. Please do not hesitate to get in touch if your business would like to discuss any of these issues or if you are a senior executive or senior professional in the financial services sector looking for practical and strategic employment law advice on your own situation.
(Source: FCA – DP21/2: Diversity and inclusion in the financial sector – working together to drive change (fca.org.uk))
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