SUMMARY AND KEY HIGHLIGHTS
The Financial Conduct Authority (“FCA”) has recently announced that financial companies in the UK are facing a regulatory crackdown unless they improve diversity standards on their board of directors and amongst their employees. The regulatory body has stated that it is considering making it a requirement for companies who wish to list in the UK to meet the required diversity measures. In the US, the Nasdaq in its listing rules, requires all companies to have, or at least explain why they don’t have, at least two diverse directors on its board, as a requirement for all companies listing on its US exchange. The FCA is potentially exploring whether similar requirements are needed as part of their UK premium listing rules, indicating that they clearly recognise the need to put in place enforceable rules in order to see more positive and impactful change to improve diversity amongst the financial services industry, where diversity is notoriously lacking.
BACKGROUND
A recent speech by the FCA’s CEO, Nikhil Rathi, at the HM Treasury Women in Finance Charter Annual review, highlighted the key challenges facing the industry and the need for change, particularly on gender equality and ethnicity.
Key highlights from the speech are:
- the charter, which challenges the financial services industry to publish measurable targets and actions;
- diversity is crucial when considering vulnerability, particularly around the pandemic, which has disproportionately affected women and people of colour;
- the FCA is now fully aligned with the Prudential Regulation Authority (“PRA”) on a joint approach to diversity and inclusion (“D&I”) for all financial services firms; and
- the FCA is considering whether to make diversity requirements part of the premium listing rules.
“Research has suggested that greater gender diversity improves risk management culture and decreased the frequency of European banks’ misconduct fines” [1] so it’s clear to see there are benefits to greater diversity, with diversity in ethnicity also playing an important part.
The FCA has created a spotlight on an issue that has increasingly gained credence during the pandemic, with a strong business case for the most diverse companies outperforming their peers by 35%, according to recent McKinsey research [2]. In addition, The Parker Review [3] reported that only 80 directors in the FTSE 250 were people of colour, with very few holding the positions of CEO or Chair. Alongside this statistic, the number of women of colour in senior positions in financial services was also highlighted as a concern.
Underpinning this theme, is the lack of diversity at a senior level, which raises questions about the firm’s ability to understand the different communities they serve and their varying different needs. A firm can only adequately respond to its consumers if they have the right diversity of background and experience required to overcome biases and blind spots. Ultimately, the requirement for D&I is needed in terms of fairness across society and to strengthen consumer outcomes.
FCA’S CONDUCT QUESTIONS
The FCA has taken this one step further by introducing five conduct questions to help focus the minds of individuals holding senior management positions at regulated firms, on conduct risk, with consideration for adding a sixth question, specifically focusing on diversity and inclusion: “Is your management team diverse enough to provide adequate challenge and do you create the right environment in which people of all backgrounds can speak up?” Specifically looking beyond representation and focusing on a firm’s culture and the need for inclusion, is whether individuals feel comfortable in their work environment such that they can demonstrate, share and bring their diversity of experience and background into the workplace. In reality, every firm, in all industries, should be considering this question as they embark on D&I initiatives and truly want to push for positive change with respect to inclusivity.
This announcement marks a welcome shift in the FCA’s level of focus on D&I which has long been highlighted as a concern. With data suggesting that fewer than 1 in 10 management roles in financial services are held by black, Asian or minority ethnic people (“BAME”), it’s clear the industry has a long way to go. Failure to see adequate improvement in D&I representation will enable the regulator to move one step further in utilising its current supervisory powers to enact the necessary change. The FCA is considering whether diversity of management teams at the firms it regulates should be part of its Senior Managers and Certification Regime (“SMCR”). The focus would be on the inclusivity of the management culture they create and whether there is an environment in which people of all backgrounds can speak up. This could potentially form part of the regulator’s consideration of senior manager applications during the authorisations process and through supervisory engagement.
THE NEED FOR A ‘SPEAK UP’ CULTURE
The importance of D&I also feeds into the FCA’s recent “In confidence, with confidence” campaign [4], which focuses on individuals working in financial services to feel encouraged to report wrongdoing in the areas that the FCA regulates. This aligns with the regulator’s focus on creating an environment in which individuals, from all backgrounds, feel safe to speak up but is also incumbent on leaders to “listen up”. A truly diverse and inclusive culture is also one where management listens, especially in a work environment where BAME employees are still experiencing racism at work, and BAME employees must feel able to speak up and feel like they are being listened to [5]. A campaign led by the FCA highlights the importance of regulated firms having robust whistleblowing policies and procedures in place, which helps remind individuals of the confidentiality processes that protect whistleblowers against the fear of retaliation from senior management or even dismissal. Whistleblowing is central to identifying breaches and is emblematic of an individual making the choice to set the “tone from within” and “not turning a blind eye to poor conduct.”
As part of the FCA’s whistleblowing campaign [6], the FCA has (or is):
- published materials for firms to share with employees;
- updated its website to provide refreshed information for whistleblowers which includes the FCA’s aim to protect the whistleblowers’ identities, what the FCA will do with information that it receives and how whistleblowers can liaise with a dedicated FCA case manager;
- developing a confidential webform to allow whistleblowers to make disclosures, widening the means by which disclosures can be made; and
- reminded firms that they must have in place effective whistleblowing policies and procedures to allow employees to raise concerns safely.
Senior FCA Adviser (and former COO), Georgina Philippou, delivered a speech at the ‘Building Ethnic Diversity and Inclusion in Investment Management’ forum in March 2021, which highlighted that leaders must also play their part:
“One small mis-step from a senior person can undermine a brilliant strategy and years of action. Being a strong leader means creating an environment where employees feel listened to and a culture that encourages both speaking and listening up.”
INVESTOR INTERVENTION
Many investors are also paving the way for change, with Goldman Sachs (“GS”) a leading investment bank, only underwriting IPO’s in the US and Europe where the company listing has at least one diverse board member, with specific focus on women. GS has further confirmed they would raise this target to two diverse candidates for each IPO client next year. David Solomon, GS CEO cited the recent performance of public offerings of US companies with at least one female director, has been “significantly better” in the last four years than those without.
Taking the lead from GS, the FCA has requested all capital market participants to consider the reasons why there are so few female C-suite executives of colour presenting during IPOs or when capital is being raised. This direct feedback will help the FCA better understand the challenges faced in financial services and more importantly, what the regulator can do to sponsor and celebrate female BAME business leaders and entrepreneurs and ensure the financial services industry culture is more inclusive.
The FCA, collectively with market participants, can help drive D&I initiatives to reduce conduct risk, but practical intervention is required by the regulator to really enforce D&I on firms that run the risk of not adequately serving their diverse communities by failing to reflect society. It’s at this point, D&I become regulatory issues with renewed focus.
NEXT STEPS
The recent FCA speeches show that there is still significant work to be done to improve D&I in the financial services sector. There are steps the FCA is taking with the PRA in formalising a joint regulatory approach to D&I to help drive real change, including potentially changing the way in which it considers senior manager applications and introducing diversity requirements to premium listing rules. The regulator is also pushing firms to address longstanding inequality and diversity concerns in financial services as well as in senior management roles, whilst strengthening whistleblowing practices, to enable any individual of whatever background, to have the confidence to speak up. However, now more than ever, it is critical that firms treat this as a regulatory imperative and take appropriate steps to embed D&I into the way they conduct their business to deliver real and effective change in the financial services sector. Failure to do so, may force the FCA to impose diversity quotas and targets at board level to implement real and necessary change by using its existing supervisory powers.
To review the McKinsey report, please click here.
To review The Parker Review, please click here.
For more information, and any guidance or advice on the FCA’s review of Diversity and Inclusion standards, Cleveland & Co External in-house counsel™, your specialist outsourced legal team, are here to help.
[1] Speech by Nikhil Rathi (CEO of the FCA) at the launch of the HM Treasury Women in Finance Charter Annual Review (17 March, 2021)
[2] Mckinsey report: Diversity wins: How inclusion matters (19 May, 2021)
[3] Ethnic diversity of UK boards: The Parker review (23 March, 2021)
[4] FCA launches ‘In confidence with confidence’ campaign to encourage individuals to report wrongdoing (24 March, 2021)
[5] Speech by Sheldon Mills (Executive Director in Consumers and Competition, FCA) at the Accelerating Black Inclusion research launch, New Financial (22 April, 2021)
[6] FCA launches ‘In confidence with confidence’ campaign to encourage individuals to report wrongdoing (24 March, 2021)
