UK FCA’s Consultation Proposes Regulatory Action on D&I in Financial Sector

The UK Financial Conduct Authority (FCA) recently launched a consultation on the creation of a robust new regulatory framework on diversity and inclusion (D&I) in the financial sector. With its new consultation, the FCA has made it clear that it considers D&I to be a regulatory concern.

In its accompanying consultation paper (the Consultation Paper), the FCA [1] 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, the FCA 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

In service of the FCA’s goal, 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 into staff fitness and propriety assessments, the FCA Conduct Rules, and the suitability criteria for firms to operate in the financial sector (Threshold Conditions)
• 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, the FCA acknowledges that a “one-size-fits-all” approach to the implementation of its proposals would be inappropriate. Rather, the FCA intends to apply proposals to firms on a proportionate basis. All FSMA firms with a part 4A permission will be subject to a minimum standard aimed at reducing discrimination and misconduct. Additional requirements will then apply to solo-entity firms (rather than group entities) with an average of 251 or more employees over a certain time period (Large Firms) (excluding Limited Scope SM&CR firms, regardless of their size).

PROPOSALS FOR FIRMS OF ANY SIZE

In order to establish a minimum standard for firms of any size to reduce discrimination and misconduct, the FCA proposes to embed non-financial misconduct, including bullying, harassment, or similar behaviour, into (1) fitness and propriety assessments for employees and senior personnel; (2) the FCA Conduct Rules, and (3) the suitability guidance on the Threshold Conditions (which set out the minimum standards to become authorised to carry on regulated activities). The FCA also proposes to add guidance on how non-financial misconduct should be incorporated into any regulatory references.

Additionally, in order for the FCA and Prudential Regulation Authority (PRA) to monitor which firms are within the scope of the additional requirements for Large Firms, the FCA proposes that all FSMA firms with a part 4A permission (excluding Limited Scope SM&CR firms) must report annually on their average number of employees over a certain period of time.

PROPOSALS FOR LARGE FIRMS

As noted above, 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 below.

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. Further, any strategy 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 to the FCA and PRA in numerical figures 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. In other words, during the first year the requirements are in place, Large Firms will be asked to report on a “comply or explain basis,” meaning that they should report such data as is reasonably practicable and explain the reasons for any gaps and how these will be closed. Large Firms will also be required to make public disclosures on the same D&I data in order to increase transparency and scrutiny.

The FCA is aware of the challenges many firms currently face when attempting to collect good-quality data, as well as the fact that many firms will not yet have established systems to collect this data. Accordingly, it has acknowledged that this proposal will require considerable time and effort from firms.

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 FCA’s proposals around improving D&I in the financial sector will be unlikely to surprise firms, given that they follow the FCA and 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 Consultation Paper and 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. The proposals are reportedly facing backlash from many financial services firms, particularly in relation to the proposals around data collection and reporting [2]. Many firms are concerned that these proposals will represent a significant new burden for firms, from both a data protection and administrative standpoint. Although it appears that the FCA has attempted to apply the data collection and reporting proposals proportionately to Large Firms only and considered the data protection angle, many firms have nonetheless expressed concern regarding employee privacy and called for the FCA to offer clarity on how the data will be used to support diversity in the industry.

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.

Additionally, the FCA’s proposals should be considered in the broader changing landscape of financial services regulations. For instance, the FCA’s proposals were shortly followed by confirmation from the FCA and PRA that the cap on UK bankers’ bonuses would be removed as of 31 October 2023.

Although touted as a measure to buoy the City of London post-Brexit, the removal of the cap also means that financial services firms will regain the ability to set their own ratios between fixed and variable pay. This means that firms will regain the flexibility to restructure pay in ways that will not only attract new talent, but can also respond appropriately to economic downturns, foster better conduct, and encourage prudent risk management.

In effect, the removal of the cap means that financial services firms will have increased flexibility over how they align any incentives with effective risk management and good conduct. In light of the FCA’s emphasis on embedding non-financial misconduct into fitness and propriety assessments, Conduct Rules and the suitability criteria for firms and improving D&I more generally, it is possible that firms will utilise variable pay as another tool with which to discourage individual misconduct, including non-financial misconduct.

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.