Sushil Kuner
Principal Associate
UK Financial Services Regulation
Head of UK FinTech Accelerator
Article
15
In September 2023, the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) published their long-awaited consultation papers on diversity and inclusion (D&I) for FCA-regulated and PRA-regulated firms, respectively[1].
While there are some differences in approach between the FCA and PRA – with the PRA's proposals setting higher standards for PRA-regulated firms due to the systemic risks they pose – both the PRA and FCA recognise that greater D&I can create better outcomes for consumers and markets. In their view, it adds value through supporting healthy work cultures, reducing 'groupthink'[2], unlocking talent, and improving understanding of diverse consumer needs and risks that could threaten firm safety and soundness (Regulatory Aims).
In this article, we set out the background to the consultations, summarise the key proposals for the FCA and PRA, respectively, and outline next steps for firms.
Over the last few years, lack of diversity has been highlighted as a contributing factor to the 2008 financial crisis. According to the FCA, looking at risk management outcomes, and studies that compared the outcomes between diverse and non-diverse boards following the crisis, those businesses with more diverse and risk averse boards achieved better overall outcomes. There is also evidence that firm cultures that are inclusive and receptive to employees are likely to generate better judgements and decision-making, and reduce the risk of groupthink[3]. As such, the FCA has been taking an increasingly rigorous approach in this area in the last few years, questioning the approaches of firms to D&I.
In July 2021, the FCA, PRA and the Bank of England (BoE) (together, the Regulators) published a joint discussion paper on the topic of D&I in the financial sector (the DP).[4] In it, the Regulators recognised that despite years of discussion, the conversation around D&I was still in its infancy and that, as a sector, there was still a long way to go. Here, they highlighted the large gender and ethnicity pay gaps that existed at the time, there being large parts of the industry with a complete lack of diversity at senior levels and products offered to consumers that did not meet the diverse needs of those who they were intended to serve.
The aim of the DP was to accelerate meaningful progress across the financial sector and the Regulators proposed a number of potential policy options which they considered could accelerate change. Proposals included: requiring firms to have regard to diverse representation when succession planning at board level; making senior leaders directly accountable for D&I through the Senior Managers Regime; linking progress on D&I to remuneration as a key tool for driving accountability in firms and incentivising progress; and requiring firms to publicly disclose a selection of aggregated diversity data on firms' senior management populations and the employee populations as a whole, as well as their D&I policies.
In the DP, the Regulators committed to taking account of feedback received, with a view to consulting on more detailed proposals. These proposals have now been published and are summarised below.
The FCA's proposals are intended to apply proportionately, based on the size and nature of firms' activities.
Baseline standards will apply to all authorised firms with a Part 4A permission under the Financial Services and Markets Act 2000 (FSMA), with the aim of reducing discrimination and misconduct.
Additional requirements are proposed to apply to 'large firms' (being those with 251 or more employees[5]) and, to align with the PRA, all dual-regulated UK Capital Requirement Regulation (CRR) firms (which include banks, building societies and the largest investment firms) and Solvency II firms (comprising insurance and reinsurance undertakings). These additional requirements would not apply to Limited Scope firms under the Senior Managers and Certification Regime (SMCR), regardless of their size.
So that firms cannot circumvent the rules, all FSMA firms with a part 4A permission, excluding Limited Scope SMCR firms, would be required to report employee numbers to the FCA annually on RegData. This is intended to allow the FCA to determine who is in scope of the additional requirements.
We summarise in the sections below the key policy proposals and their application to firms.
Application – All authorised firms with a Part 4A permission under the FSMA and where relevant threshold conditions and existing chapters of the FCA apply.
Non-financial misconduct will be explicitly included within:
Guidance on how non-financial misconduct should be incorporated into regulatory references will also be added.
The PRA consultation paper places emphasis on improving D&I within PRA-regulated firms as a means of reducing groupthink while also promoting both its primary and secondary objectives.[9] The proposals contained in the PRA's consultation paper have largely been shaped by the responses received in relation to the DP, with the PRA factoring in the current practices of regulated firms into its proposed policymaking.
Given the broad range of firms regulated by the PRA, it has carefully considered how to tailor the proposed policy package to apply in a proportionate manner, thereby allowing firms to tailor various policies to their business model, size, and location. While the majority of new rules and expectations would come into effect one year after publication of the final policy, a number of the below proposals will have extended timescales.
Below is a summary of the key proposals made by the PRA.
Application – All CRR and Solvency II firms with respect to their establishment in the UK, including third country branches.
Proposals will require firms to have and publish on their websites: (i) a firmwide strategy; and (ii) a board strategy, each promoting D&I.
Firms can develop their own strategies, however, the PRA expects a strategy to include:
Firms can choose to combine or keep separate their board and firmwide strategies, but they must both be accessible on their website.
Firms will be required to regularly review and update their strategies.
All firms will have the flexibility to tailor their strategy to meet their circumstances. Smaller firms' strategies are expected to be less comprehensive than those of larger firms, and third country branches covered by a D&I strategy at international group level would have to consider relevant aspects.
Senior leadership and the board are to be responsible for the strategy, and are to support and disseminate information about the strategy within the firm, including, for example, via formal training.
The PRA proposes to clarify in the new supervisory statement that not only internal audit, but also risk management and compliance functions have a role to play in assessing the firm's risk management and controls framework around D&I. Therefore, the PRA expects firms to adopt appropriate risk and control functions to support the development and review of each firm's D&I strategy. The PRA will not be prescriptive as to risk and control functions.
12 months after publication of final rules
12 months after first report
If the report is not completed on time, firms will be subjected to the FCA's standard £250 administrative fee, as per other FCA reporting requirements. This would be supported by supervisory and enforcement powers in the event of continued non-compliance.
The proposals in the FCA and PRA consultation papers differ somewhat to those set out in the DP, with many of the original proposals not featuring at all in the FCA's consultation, including, for example, mandatory training, linking remuneration to D&I metrics, board recruitment and succession planning etc. The FCA and the PRA appear to have listened to feedback to the DP and have attempted to adopt a proportionate approach, depending on the size and nature of authorised firms.
The final policy statements are expected in 2024 and firms have until 18 December 2023 to respond to the FCA and PRA consultation papers.
If your business is impacted and you have any questions, feel free to get in touch with Sushil Kuner from our Financial Services Regulatory team.
Footnotes
[1] See FCA Consultation Paper (CP23/20) dated September 2023 on Diversity and Inclusion in the Financial Sector – working together to drive change and PRA Consultation Paper (CP18/23) dated 25 September 2023 on Diversity and Inclusion in PRA-regulated firms
[2] The practice of making decisions as a small group which are perceived to represent a consensus.
[3] See FCA Discussion Paper (DP21/2) dated July 2021 on Diversity and Inclusion in the Financial Sector – Working Together to Drive Change
[4] See FCA Discussion Paper (DP21/2) dated July 2021 on Diversity and Inclusion in the Financial Sector – Working Together to Drive Change
[5] To reduce the regulatory burden of firms moving in and out of scope of the additional requirements, the FCA is proposing to rely on the average number of employees over a rolling three year period as at a specified annual reference date.
[6] The Code of Conduct chapter within the FCA Handbook.
[7] The Fit and Proper Test for Employees and Senior Personnel, contained within the FCA Handbook.
[8] The Threshold Conditions chapter in the FCA Handbook
[9] The PRA's primary objectives are the promotion of the safety and soundness of the firms it regulates and securing appropriate protection for policyholders, while its secondary objectives are the facilitation of competition, competitiveness and growth.
[10] The method of calculation of this threshold will be set out in the Glossary of the PRA Rulebook.
[11] See SS5/16 here: Corporate governance: Board responsibilities
[12] CRR firms with assets greater than £250 million and Solvency II firms, but not third country branches
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