On 7 July 2021, three UK regulators (the Financial Conduct Authority (FCA), Prudential Regulation Authority (PRA) and the Bank of England) published Discussion Paper 21/2: Diversity and inclusion in the financial sector – working together to drive change (DP 21/2).

The regulators have asked for comments on DP 21/2 to be provided by 30 September 2021.

In addition to regulated firms in the sector, the regulators are welcoming comments from consumer groups, trade bodies, policy makers, industry experts, academics and organisations representing the interests of groups of people.

A Collective Commitment to Faster Change

In DP 21/2, the regulators acknowledge that the financial sector has taken steps forward on diversity and inclusion. Despite this, the regulators note that more needs to be done to create truly diverse and inclusive sector.

Large gender and ethnicity pay gaps still exist in the financial sector. There are some parts of the industry which lack diversity at senior levels, and some of the products offered to customers still do not meet the needs of disadvantaged groups. In publishing DP 21/2, the regulators are aiming to accelerate the pace of meaningful change in the sector.

There is clear momentum for change. Environmental, Social and Governance (ESG) issues are rising to the top of the agenda for corporates, investors and wider society. This is helpfully keeping diversity and inclusion at the forefront of the minds of boards, executives and staff.

Against this background, the regulators state in DP 21/2 that they need to make their expectations of firms clearer and root them in their statutory objectives, supported by the Public Sector Equality Duty introduced by the 2010 Equality Act.

The regulators acknowledge that many existing initiatives on diversity and inclusion have been driven by sector-specific developments. This has resulted in a fragmented requirements for different types of financial firms.

The regulators also acknowledge that they, as employers, have more work to do in encouraging diversity and inclusion.

Regulated Firms in the Financial Sector

DP 21/2 refers to “firms” broadly in the financial sector. This includes firms regulated jointly by the PRA and FCA under the Financial Services and Markets Act 2000 (banks, building societies, designated investment firms, credit unions and insurance firms) or those solely regulated by the FCA such as payment services and electronic‑money firms, credit rating agencies and recognised investment exchanges.

In addition, “firms” included in DP 21/2 also extends to Financial Market Infrastructures (FMIs) which are supervised by the Bank of England.

Broad Definitions of Diversity & Inclusion

In DP 21/2, the regulators define diversity broadly as the bringing together of a “range of different styles of thinking among members of a group. Factors that could lead to diverse thinking could include, but not be limited, to different perspectives, abilities, knowledge, attitudes, information styles, and demographic characteristics, or any combination of these.”

Diversity of thought can be influenced by many factors including demographic characteristics which may affect viewpoints and life outcomes. These can be visible and measured, such as gender, age and ethnicity, or non‑visible, such as disability, sexual orientation and education. They do not only include the nine protected characteristics defined in the Equality Act 2010 (age, disability, gender reassignment, marriage and civil partnership, pregnancy and maternity, race, religion or belief, sex and sexual orientation), but can also include other factors, such as socio‑economic diversity, gender (including where it does not coincide with sex), and cultural background.

The regulators note that diversity alone is not enough. Much of the focus in this space has tended to be on diversity without equal concern being paid to the importance of inclusivity.

In DP 21/2, the regulators define “inclusion” broadly as being “the practice or policy of providing equal access to opportunities and resources for people who might otherwise be excluded or marginalised, for example due to demographic characteristics”. An inclusive culture allows individuals to participate fully and where views and contributions are valued and fully considered regardless of differences due to demographic characteristics or background.

The concepts are interconnected. Greater diversity should support having a range of views across an organisation, while inclusion should create the necessary environment for individuals to be able to express these views, speak up and raise concerns.

The Benefits of Change

In DP 21/2, the regulators cite some of the growing evidence that diversity of thought, when part of an inclusive culture, supports better decision making by firms.

For example, the regulators cite the academic work of Arnaboldi et al (2020)[i] who examined fines received by EU banks from US regulators. They found that greater female representation on the board significantly reduced the frequency of misconduct fines with female directors more influential once they reached a “critical mass”.

Alongside DP 21/2, the regulators published a literature review with the developing evidence of the impact of diversity and inclusion in the workplace.

Diversity and inclusion can reduce groupthink, encourage debate and innovation and thereby improve outcomes for consumers and across markets, supporting financial stability. According to the regulators, diversity and inclusion make business sense - from both a financial and a consumer perspective. It also assists in meeting their statutory objectives in that diversity and inclusion contribute towards well-functioning markets, the integrity of the financial system, consumer protection and promote effective competition.

Measuring Progress

In DP 21/2, the regulators outline the importance of data collection, reporting and monitoring advances in diversity and inclusion. Firstly, high quality data supports evidence based policymakers by helping regulators identify ways in which they can make the most effective policy interventions, support supervisory interventions and the shift to data-driven regulation. Secondly, they enable regulators to monitor firms’ progress towards their stated objectives and targets.

Currently, data commonly collected by firms are around gender (broken down by division, function and seniority). More advanced firms are also collecting data on ethnic minorities and how these groups move throughout the employee lifecycle including recruitment, promotion and attrition.

The Regulators propose in DP 21/2 to launch a one-off, voluntary pilot data survey in Autumn 2021. This survey will allow the regulators to understand more deeply categories of data firms collect as well as what strategies firms are undertaking. The data collected will inform future regulatory policy development. The survey will involve a representative sample of solo-regulated firms, all firms jointly regulated by the PRA and FC and selected FMIs. Firms to be included in the sample will be contacted by the regulators in due course.

Driving Change: Culture and Policy

Chapter 5 of DP 21/2 sets out some potential policy options that the regulators consider could be effective in driving progress on diversity and inclusion in firms.

The regulators state that any such policy drivers will be proportionate given the differences between firm size and complexity. Whilst the regulators note that they will not be adopting a one-size-fits-all approach, the regulators also stressed that smaller firms will not necessarily be out of scope.

One option the regulators contemplate in DP 21/2 is adapting the Senor Managers and Certification Regime (SM&CR) categorisation of firms as enhanced, core and limited scope when it comes to diversity and inclusion requirements. The regulators are also seeking views on whether overseas firms that operate in the UK through branches should also be in-scope of these requirements.

1. Tone from the Top

The regulators note the importance of the board and senior managers of firms in establishing inclusive cultures and monitoring/challenging progress on diversity.

The regulators expect that diversity and inclusivity is a key consideration in recruitment (and succession planning) of board members whilst acknowledging this needs to be considered proportionally for firms with smaller sized boards.

The regulators acknowledged that the SM&CR is an important policy tool for making senior leaders at in-scope firms directly accountable for diversity and inclusions in firms. Two of the PRA’s Prescribed Responsibilities dealing with culture must be allocated to approved Senior Managers in dual-regulated firms. In DP 21/2, the regulators noted that these Prescribed Responsibilities could be amended to make the link between culture and diversity and inclusion even clearer.

For firms that do not have to allocate these Prescribed Responsibilities, the regulators envisage that the need to drive diversity and inclusion could be mandated as part of Senior Managers’ Statements of Responsibilities.

The regulators in DP 21/2 also contemplate linking progress on diversity and inclusion to remuneration (both fixed and variable) as a key tool for driving accountability in firms and incentivising progress. The regulators could develop guidance on how metrics linked to diversity and inclusion could be used as part of the non-financial criteria when setting variable remuneration awards. Similarly, poor performance in this area could be grounds for adjustment.

2. Firm-wide Policies & Practices

In DP 21/2, the regulators note the importance of firms having in place a diversity and inclusion policy. Clearly documented policies help set out expectations for all staff. The regulators do not propose to be prescriptive about the content of these policies. At a minimum, however, these policies should promote diversity of the board.

Available data indicate less diversity towards the top of firms. This is where key decisions that have significant impacts on safety and soundness, consumer protection and markets regularly take place. Accordingly, the regulators propose that future initiatives should focus on the diversity of senior management and the progress that firms are making. A consistent definition of “senior management” across all regulated firms for the purposes of monitoring diversity would support benchmarking between peers. This definition may also be used by the regulators in any future diversity reporting and disclosure policy.

In DP 21/2, the regulators also are seeking views on the merits of targets to improve board and senior management diversity as well as customer-facing roles. Where targets are used, the regulators expect them to be stretching enough, with a defined timeframe, to contribute towards meaningful change.

The regulators also note that employees at firms should understand that the reasons why diversity and inclusion is important to their firm. The regulators are aware that evidence for some diversity training is mixed.

The regulators also intend to consult on requirements to publicly disclose a selection of diversity data on the senior management and employee population as a whole, as well as relevant policies.

3. Regulatory Measures

Before a Senior Manager subject to the SM&CR is approved to carry out a controlled function, the firm and its regulators must be satisfied that the person is “fit and proper” to carry out their role. This includes an assessment of the individual’s honesty, integrity and reputation. The Bank of England scrutinises candidates for senior management roles at FMIs in a similar way.

In DP 21/2, the regulators note that they are exploring whether adverse findings when it comes to fitness and properness should affect its assessments in the future. There have been instances where the FCA has found an individual not to be fit and proper on the basis of “non-financial misconduct”. The regulators could develop guidance on what such misconduct constitutes. It may include evidence of sexual harassment, bullying and discrimination on the basis of someone’s protected (or otherwise) characteristics. Regulators may also collect diversity data about the individual as part of the information provided in Senior Management Function applications, subject to applicable data protection rules.

More broadly, the regulators note that evidence of a firm engaging in discriminatory activities could itself result in that the firm not meeting its threshold conditions to carrying out regulated business in the UK. Going forward, the regulators intend to embed diversity and inclusion into their existing supervisory practices.