FCA Reflections: Diversity and Inclusion – A Regulatory Matter

Posted on 24 May 2021

On 17 March 2021, Nikhil Rathi, the FCA's CEO, spoke at the launch of the HM Treasury Women in Finance Charter Annual Review on why diversity and inclusion (D&I) is a regulatory issue. Rathi stated that "in the years ahead, if we don’t see improvements in diversity at senior levels and better answers [to questions about D&I], we will…consider how to best use our powers". This article addresses the following: (1) why the FCA considers D&I to be a regulatory matter, (2) how the FCA may seek to use its powers, and (3) poses areas of potential reflection for firms.

Rathi's stated that the FCA cares about D&I because "diversity reduces conduct risk and those firms that fail to reflect society run the risk of poorly serving diverse communities", "not [just] because it is a social good - although, frankly, that should be enough". Rathi quoted McKinsey research which suggests "the most diverse companies, for example, are 35% more likely to outperform the least diverse". Further, Rathi referred to The Parker Review which reported that "there were only 80 directors of colour in the FTSE250 - 5% of the total". He then highlighted that "the number of women of colour in senior positions in financial services is a particular concern".

Rathi suggested the FCA will, if required, use its powers to correct these failures. This motivation is premised on the positive correlation between D&I and a reduction in conduct risk. The question then is what powers, formal and informal, does the FCA have to implement this objective? Georgina Philippou, Senior Adviser to the FCA on the Public Sector Equality Duty, spoke to this point at the Building Ethnic Diversity and Inclusion in Investment Management Report Launch on 16 March 2021. She explained that whilst "there is no rule in [the FCA] Handbook that says regulated firms have to be diverse…that doesn't mean we are silent or powerless". She explained that the FCA views D&I as relevant to, among other areas, high level principles such as "integrity", "treating customers fairly" and "ESG strategies". Noting the above, the FCA may engage with firms in the following ways:

  1. Supervisory engagement: An element of the FCA's supervisory engagement with firms will be, as Rathi suggests, asking "tough questions" about "representation across grades and whether [a firm's] culture is open and inclusive". For example, Rathi proposed an extra question to the 5 Conduct Questions (5CQ) which is: "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?" As the reader will know, the 5CQ are five questions which the FCA intends to be a tool for firms to help them improve their conduct risk management, and, ultimately, drive cultural change within firms.
  2. Listing rules: Rathi pointed out that the US Nasdaq has "take[n] the lead" by requiring all companies listed on its US exchange to have, or explain why they do not have, at least two diverse directors. Rathi suggested the FCA will explore whether it should make "diversity requirements part of [its] premium listing rules". Interestingly, the Listing Rules already require premium listed companies to comply or explain against the UK Corporate Governance Code.
  3. Authorisations and SM&CR: Firms may wish to consider how diverse they are, especially when applying for senior manager authorisations, given the FCA may already be scrutinising applications through this lens.

Readers will know the importance the FCA places on conduct risk, especially given that the 5CQ programme is applicable to all firms it regulates. Much like it did with non-financial misconduct (NFM), the FCA is putting down a clear marker as to its expectation. The FCA has shown its teeth in relation to NFM cases, by, among other things, banning three individuals from working in the financial services industry for NFM in November 2020.

It would be reasonable to expect the FCA to use its powers, formal and informal, where necessary, given D&I is a regulatory matter with real implications for conduct risk. The FCA is taking measurable steps to improve its D&I and it will expect the firms it regulates to do the same. In light of this, firms may wish to reflect on how they will respond to the likely questions about D&I the FCA may pose given the obvious merits of a diverse organisation.

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