Financial service providers (“FSPs”) need to take issues of diversity and inclusiveness seriously, or face some unpalatable consequences. Lack of diversity at senior management is considered by the Central Bank of Ireland (the “Central Bank”) and other regulators to be a leading risk indicator, including prudential risk. Failing to ensure diversity and inclusiveness at all levels, including senior management, may lead to both regulatory and reputational difficulties for an FSP.
Diversity and the Financial Crisis
The financial crisis shed a spot-light on both the lack of diversity at senior levels in banks and other FSPs and the detrimental consequences associated with that lack of diversity. Specifically, one of the key contributory factors in the financial crisis was “group think” and greater diversity at the top of corporations tends to avert group think, leading to better decision making. According to the 2016 Empowering Productivity Report 1, which was sponsored by the UK Treasury and the Bank of England:
Diverse groups tend to have a well-rounded view on business issues and risks. It is widely believed that greater diversity of thought results in better decision making and improved corporate governance and risk management, thus avoiding the perils of “group think”.
In a similar vein, according to ESMA and the EBA, a more diverse management body can reduce the phenomenon of “group think” and facilitate independent opinions and constructive challenging in the process of decision making.
Nevertheless, many FSPs have a very homogenous composition at senior levels. In 2017, the Central Bank published data on the level of gender diversity at senior levels of regulated entities, which included analysis of nearly 18,000 applications received by the Central Bank for pre-approval for senior roles as part of its fitness and probity regime. According to that data in 2017, 18% of applicants at board level and 30% of applicants at senior management level were female. There does not appear to be any studies on racial or ethnic diversity in FSPs in Ireland.
Diversity and the Law
Large companies are generally required to disclose diversity and other non-financial information under the European Union (Disclosure of Non-Financial and Diversity Information by Certain Large Undertakings and Groups) Regulations 2017 (see our previous briefing here).
Moreover, credit institutions, investment firms, insurers and reinsurers are each under a specific legal obligation to put in place a diversity policy.
Regarding credit institutions and investment firms, CRD IV and MiFID require such institutions to ensure that they engage a broad set of qualities and competences when recruiting members to the management body. For that purpose, each institution must put in place a policy promoting diversity on the management body in terms of age, gender, geographical provenance and educational and professional background. ESMA and the EBA have published guidelines on these requirements, which came into force on 30 June 2018. The guidelines specify how diversity is to be taken into account in the process for selecting members of the management body and set out requirements regarding the diversity policy.
The Central Bank’s Corporate Governance Codes also set out diversity requirements. According to the Corporate Governance Requirements for Insurance Undertakings 2015, the board must establish a written policy on diversity with regard to the selection of persons for nomination as board members. The Corporate Governance Requirements for Credit Institutions 2015 also contain the same requirement.
More broadly, the Central Bank considers diversity and inclusion to be important components of well-managed, financially resilient, strategically-minded firms and, therefore, relevant to the Central Bank’s mandate of safeguarding stability and protecting consumers. In a speech delivered in November 2017, Ed Sibley, Deputy Governor of the Central Bank stated 2:
We can include diversity considerations in governance inspections and we can consider [it] as part of root cause analysis when we have concerns regarding behaviour and culture, or when serious issues emerge. Above all, we can hold boards and executives to account to ensure that they are delivering as many have committed to do.
Moreover, in a speech delivered on 4 May 2018, Deputy Governor Sharon Donnery stated that, “in the absence of improvements in diversity at senior levels in regulated firms, the Central Bank will have to consider whether it is necessary to put specific requirements in place.” 3
In view of the mounting evidence that diversity is an important component of good governance, each FSP should review the composition of its senior management and give careful consideration to how to increase its diversity, where this is warranted.
In its recent report on Behaviour and Culture of the Irish Retail Bank 4 (the “Report”), the Central Bank shed further light on its expectations regarding diversity, which appear to be of general relevance.
The Central Bank’s expectations include that the board and senior management:
- approve the diversity and inclusion policy and subject them to annual review and regular discussion;
- actively consider the construction of the board, the executive and key committees to identify actions that would enhance the levels of diversity of thought and effective challenge within them, so as to improve decision-making and risk management;and
- approve and are progressing a clear plan to implement these actions.
According to the Central Bank, each action plan should
- include clear expectations, stretch measures and implementation targets;
- consider a range of measures of diversity and consider what is required to identify and mitigate relevant risk factors;
- be subject to annual review, with effectiveness measured against suitably ambitious outcomes and targets; and
- enhance the approach to resourcing, succession planning and recruitment.
Each FSP should take the above expectations into consideration in the context of its own approach to diversity. Moreover, in devising an action plan, it is important to remember that diversity is not solely a numbers issue. For diversity to promote performance, it must exist across the management body and not just in specific areas. For example, according to Central Bank data, the proportion of female applicants in control functions is considerably higher than in front-line and/or revenue generating roles. However, these latter roles are key to how FSPs make their decisions, set their risk appetites and treat their customers. For diversity to lead to better decision making, then there must be diversity among the decision-makers, rather than in the functions supporting these decision-makers.
FSPs should also be aware that diversity, in and of itself, is not necessarily a panacea for all corporate governance ills. Indeed, in its Report, the Central Bank states:
….the early stages of enhancing diversity and inclusion in any organisation can bring risks, for example, in the development of collaborative and constructively challenging approaches to decision-making.
An FSP will therefore need to consider how to mitigate risks arising from increasing diversity. This could include taking measures to ensure that the leadership style within the FSP is sufficiently inclusive and that members of senior management learn to collaborate constructively within a more diverse and challenging environment. For example, an FSP which has a command and control leadership style is unlikely to derive the potential benefits of a more diverse board or senior management. Consequently, each FSP should take measures to ensure that it adopts an inclusive and collaborative leadership style, aimed at integrating as many people and perspectives as possible