Would regulatory action on diversity and inclusion promote healthy working cultures and reduce groupthink?

The UK’s Financial Conduct Authority (FCA) considers diversity and inclusion (D&I) to be a regulatory concern, having launched a consultation on the creation of a robust new framework on D&I in the financial sector in September 2023. 

In its accompanying consultation paper the authority explains that by increasing diversity and improving inclusion outcomes for consumers and markets will be improved by reducing groupthink, supporting healthy work cultures, unlocking diverse talent and improving understanding of and provision for diverse consumer needs.

For this reason it is proposing to take regulatory action to improve D&I efforts across the financial sector, increase the pace of meaningful change and help deliver the benefits of diverse and inclusive work environments.

Overview

The consultation paper includes proposals aiming to set clear standards and expectations for firms around D&I. These proposals include the following:

• Better integration of non-financial misconduct considerations, including bullying, harassment or similar behaviour, into staff fitness and propriety assessments, the FCA Conduct Rules, and the suitability criteria for firms to operate in the financial sector 
• A requirement for firms to report their average number of employees to the FCA on an annual basis
• A requirement for certain firms to engage in the following actions:
  • Establish, implement and maintain a D&I strategy
  • Determine and set appropriate diversity targets
  • Collect, report and disclose certain D&I data
  • Recognise a lack of D&I as a non-financial risk

In the FCA’s view, these proposals would contribute to much-needed improvements in D&I in the financial sector, including by creating higher standards of conduct and encouraging improved decision-making and risk management.

However, it acknowledges that a ‘one-size-fits-all’ approach to the implementation of its proposals would be inappropriate. Rather, it intends to apply proposals to firms on a proportionate basis.

Proposals for large firms

In addition to the proposals applicable to all firms, the FCA proposes that large firms be subject to further requirements in order to drive positive change. These will include the following.

1. D&I strategy

Large firms will be required to develop D&I strategies containing, at a minimum, the following:

• A firm’s D&I objectives and goals
• A plan for meeting those objectives and goals and measuring progress
• A summary of the arrangements in place to identify and manage any obstacles to meeting the objectives and goals
• Ways to ensure adequate knowledge of the D&I strategy among staff.
   

A large firm’s board would be responsible for ensuring effective maintenance and oversight of such a strategy, which is expected to be easily accessible and free to obtain, most likely on a firm’s website.

2. Targets

Large firms will also be required to set targets to address underrepresentation of demographic characteristics. The demographic characteristics reported will not be prescribed and instead should be determined by a firm, taking into account which characteristics would enable them to make progress in their areas of greatest underrepresentation.

Firms should set different targets to address underrepresentation at board, senior leadership and employee levels. Any targets set must be stretching but manageable, taking into account a firm’s D&I strategy and current diversity profile. Targets should also be reviewed and updated regularly to ensure that they remain demanding but realistic. Again, a large firm’s board would oversee these targets.

3. Data Reporting and Disclosure

Large firms will also be required to annually collect and report data across a range of demographic characteristics, inclusion metrics and targets via a single regulatory data return. The FCA proposes to make reporting certain demographic characteristics mandatory, including age, sex,or gender, disability or long-term health conditions, ethnicity, religion and sexual orientation. Reporting other characteristics, such as socio-economic background, gender identity and caring responsibilities, will be voluntary.

The FCA suggests that these requirements come into force 12 months from the publication of any final rules, and that, in order to enable firms to establish the necessary processes, a transitional regime could be established.

4. D&I and firm governance

Finally, large firms will be expected to incorporate D&I into their governance structures. This should include a clear understanding by large firms and their governing bodies that D&I matters are to be considered non-financial risks. Further, D&I matters should be treated appropriately within the firm’s governance structures, including human resources and risk functions such as internal audits.

Next steps 

Many of the proposals will be unlikely to surprise firms, given that they follow the FCA and Prudential Regulation Authority (PRA’s) July 2021 Discussion Paper on the topic and arrive in the wake of a number of statements from the FCA on the importance of D&I initiatives.

For some, the detailed proposals represent welcome guidance around how to approach and address D&I issues in the financial sector. Many others, however, are resistant to the FCA’s new proposals. They are reportedly facing backlash, particularly in relation to data collection and reporting. Many firms are concerned that these proposals will represent a significant new burden for firms, from both a data protection and administrative standpoint.

These proposals also come at a time when recent legal developments in the United States have led to resistance by some groups to employers’ D&I efforts, particularly following the Supreme Court’s decision in affirmative action cases involving Harvard University and the University of North Carolina. Financial services employers with a presence in the United States will need to consider how to balance emerging global regulatory requirements such as the FCA’s proposals with ongoing legal risk.

The FCA is seeking feedback on the Consultation Paper by 18 December 2023. The plan is to publicise a policy statement in 2024, with rules and reporting requirements applying from 2025.

Louise Skinner is a partner, Thomas Twitchett an associate and Cary Marshall an associate at Morgan Lewis. Read more detail on its website here