The Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) recently published long-awaited consultation papers, setting out their proposals to accelerate the pace of meaningful change on diversity and inclusion across the financial sector.
The consultations cover a wide range of topics, including the need for most firms to set, publish and report against firm-wide diversity and inclusion (D&I) strategies, reporting on demographic characteristics and inclusion data, setting diversity targets, and extensive changes to the senior managers and certification regime to clarify how non-financial misconduct is expected to be considered.
Many firms and organisations already have processes in place to achieve objectives similar to those proposed in the consultation papers. These elements of the papers are not ‘novel’ areas for employer action. However, the change in status of D&I initiatives from an employer choice to a regulatory issue — with embedded regulatory requirements to satisfy — is new.
If enacted as proposed, the scale of change would represent the most significant action to date by an industry regulator to move the dial on D&I in its sector. The decision to recast D&I as a regulatory issue rather than an employer choice presents some particularly difficult issues for employers. The global political landscape for D&I is changing and many employers are currently reflecting on the future of their D&I initiatives.
Target setting
One headline proposal for in-scope firms is to set, report and disclose board-approved and data/evidence-based targets for underrepresented demographic groups across the board, senior leadership team and broader employee population. It will generally be up to firms to set their own targets, which may also include inclusion metrics and ideally focus on their greatest areas of underrepresentation in the short to medium term.
Alongside targets, firms will need to prepare and disclose their strategy on how the targets will be met and their progress towards achieving them.
While diversity targets in the UK are not, at first glance, unlawful, there is a grey area between what constitutes lawful positive action and unlawful positive discrimination in how targets are achieved. While both regulators have noted that their proposals do not require employers to breach the provisions of the UK Equality Act relating to positive discrimination, they fail to address the nuances in approach that are required to manage the risk of positive discrimination.
This will be a particular concern for firms with a US presence, as the US Supreme Court has recently revised its position on affirmative action, causing US employers to reconsider their ability to introduce strategies designed to correct historic disadvantages.
Data reporting and disclosure
Another key element of the proposals is data reporting and disclosure. In-scope firms will be required to collect and report diversity metrics and inclusion data to the regulators on a mandatory basis for age, sexual orientation, either sex or gender, disability and long-term health conditions, ethnicity and religion. It proposes voluntary reporting for both sex and gender (in combination), parental and caring responsibilities and socio-economic background.
Mandating data gathering and reporting at this scale is a significant call to action by the regulators. If enacted, many firms will need to step up their data collation and gathering processes to meet these expectations.
The regulators have also taken a bold step in mandating inclusion reporting. Being the less tangible and harder-to-measure limb of D&I, many employers have struggled to assess and measure inclusion successfully. Irrespective of views on the proposed metrics, setting an industry-wide benchmark by which to measure inclusion across the sector helps to move the dial and sets a precedent for other industries.
While generally aligned, there are a few points of difference between the FCA’s and PRA’s proposals, which may require differing approaches by dual- and solo-regulated firms.
The PRA proposes augmenting the ‘culture’-prescribed responsibilities to cover developing and implementing the firm’s D&I strategies. Where the culture-prescribed responsibilities don’t apply, at least one senior management function is expected to have responsibility for the implementation of the firm’s D&I strategy reflected in their Statement of Responsibilities.
Senior managers will not be accountable for a failure to meet D&I targets. However, they are expected to be able to discuss why they may not be met. The FCA, meanwhile, is not proposing to introduce equivalent requirements for FCA-authorised firms.
Non-financial misconduct
In late 2018, the then FCA executive director of strategy and competition, Christopher Woolard, stated that “non-financial misconduct is misconduct, plain and simple”. Since then, the FCA has given firms little guidance on how to identify, investigate and respond to such behaviour. Nor has it been clear when and how this might impact on fitness and propriety assessments or constitute a breach of the Conduct Rules.
Outside of a few bans relating to convictions for criminal behaviour, there has been little to no enforcement action by the FCA in relation to non-financial misconduct (NFM).
The negative impact of NFM in workplaces is clear. The PRA and FCA rely on this as the basis for proposed new guidance to reflect that both bullying and similar misconduct in the workplace, and serious misconduct in a person’s personal/private life, is potentially relevant to fitness and propriety, on the basis that it could undermine public confidence in the financial system.
This is, at least in part, a response to the findings of the tribunal in the Frensham case, in which the upper tribunal criticised the FCA for failing to explain how Mr Frensham’s conduct in his private life “engage[d] the question as to whether the individual poses a risk to consumers”.
The FCA has also proposed changes to its rules and guidance to make it clear that NFM is potentially in scope of the Conduct Rules; give examples as to when something should be regarded as a work matter rather than to do with an individual’s personal/private life; explain when NFM may amount to a breach of Conduct Rule 1 (integrity) or Conduct Rule 2 (due skill, care and diligence); and highlight the responsibility of managers under Conduct Rule 2 to ensure that they deal appropriately with NFM matters.
However, the very granular approach taken by the FCA in its proposed guidance adds significant complexity to a set of rules and guidance which already lacks clarity, and in some cases risks raising more questions than it answers.
Next steps for banks
The consultation period closes on December 18, 2023. A policy statement is expected to be published during the first half of 2024, with both regulators proposing a phased implementation process for any rules and regulations and accompanying guidance thereafter.
Firms caught by the proposals will be at different stages of their D&I journey. For some firms, if enacted the proposals could lead to new challenges as they seek to operationalise the new requirements. For others, it may require making more modest adjustments to existing D&I strategies and initiatives.
All firms will find the granular public disclosure and reporting mandated by the rules a challenge. Although the proposals are in the consultation phase, the broad parameters of the proposals are unlikely to change materially, and firms would therefore do well to start planning now to ready themselves for the brave new world of D&I reporting and scrutiny.
Simon Kerr-Davis is counsel in the employment and incentives practice and diversity faculty and Nik Kiri is a partner in the financial regulation group of law firm Linklaters.
