The latest policy statement from the FCA titled PS22/3: Diversity and inclusion on company boards and executive management outlines a ‘comply or explain’ methodology to improve the representation of women and minority groups at the board level, and the overall reporting standards around diversity.
The regulator’s goal is to bring a greater focus on the diversity of company boards and executive teams and increase transparency in companies’ financial reports. In turn, this will drive D&I standards from the top down and ensure firms deliver on their diversity targets and policies.
Diversity matters. That was the clear message FCA CEO Nikhil Rathi articulated in his speech at the launch of the HM Treasury Women in Finance Charter in March 2021. It matters, he said, because the most diverse companies are more likely to outperform the least diverse, greater gender diversity improves risk management culture and conduct, and the lack of diversity at the top raises questions about firms’ understanding of the different communities they serve. It is also a matter of fairness, given the under-representation of women and people from different ethnic backgrounds in the company boardroom.
The speech was also significant in that it signposted that the FCA was already exploring whether to make diversity requirements part of its premium listing rules. Since then, the regulator has been formulating its proposals. The FCA worked with the Bank of England and the PRA to publish some initial thinking in the joint discussion paper DP21/2: “‘Diversity & inclusion in the financial sector – working together to drive change” in July 2021, and, in the same month, set out its own draft proposals in CP21/24: “Diversity and inclusion on company boards and executive committees”.
Policy statement PS22/3, April 2022, turns these proposals, with limited modification, into final requirements.
To set the new requirements into context, PS22/3 forms part of a broader FCA focus on diversity and inclusion, which is taking form against a background of wider social interest in this area. ESG brings a focus on diversity, inclusion and transparency more generally, and the new FCA requirements come hot on the heels of the FTSE Women Leaders Review report and the update report from the Parker Review published in February and March 2022 respectively.
The FCA sees its changes to the Listing Rules as a first step in setting out a new regulatory framework on diversity and inclusion that aims to deliver better outcomes for consumers in four key respects:
The new measures apply to UK and overseas issuers with equity shares, or certificates representing equity shares, admitted to the premium or standard segment of the FCA’s Official List, including closed-ended investment funds and sovereign controlled companies. Open-ended investment companies and shell companies are not caught by the new rules.
The measures are designed to improve transparency on the diversity of company boards and their executive management teams. Interestingly, the FCA appears to recognise, notwithstanding the new requirements, that they may not be enough - it stresses the importance of investor pressure on issuers to drive greater diversity in practice.
The proposals the FCA put forward in the CP21/24 were broadly welcomed, albeit a single question, concerning the proposal to include those self-identifying as women as part of the targets on the representation of women, accounted for 439 of the 540 responses. This could be a record for a single question, and, perhaps not surprisingly given the wider society interest in matters of gender and trans rights, this was the proposal that also attracted the most press comment. The compromise the FCA has settled on in the face of significant opposition is to allow companies more flexibility in how they collect diversity data for reporting against the target on women’s representation, but only on the condition that they explain their approach.
So, what are the new requirements? Firstly, there will be two new Listing Rules requiring in-scope issuers to include a statement in their annual financial report setting out whether they have met specific board diversity targets on a 'comply or explain' basis, as at a chosen reference date within their accounting period. These targets are:
Firms failing to meet these targets will have to explain why not.
In-scope companies will need to publish numerical data on the sex or gender identity and ethnic diversity of their board, senior board positions (chair, CEO, SID and CFO) and executive management. Data is to be reported in a prescribed table, which includes some flexibility for reporting on sex or gender identity, to reflect a company’s approach to data collection. Issuers will also be required to explain their approach, which will need to be consistent for both data collection across the individuals being reported on, and for reporting against the targets and numerical disclosures.
The new rules introduce greater flexibility in relation to numerical disclosures for issuers who have members of their board or executive management situated overseas, where local law prevents the collection and/or publication of relevant data. In these cases, a company may instead explain the extent to which it is unable to make the numerical disclosures when completing the tables. Similarly, closed-ended investment funds and sovereign controlled companies will be permitted to adjust their disclosures on senior board positions and their numerical data disclosures if these disclosures are inapplicable to the fund, provided they set out the reasons why that is the case.
The FCA has also provided guidance permitting in-scope companies to include, in their annual financial reports, further context on the key policies, procedures and processes that contribute to board and executive management diversity, their plans to increase diversity, any mitigating factors or circumstances which make achieving diversity more challenging, and any risks they foresee in meeting the board diversity targets in the next accounting period. However, this flexibility needs to be balanced with the fact that they remain responsible for ensuring their practices are lawful and compliant with equalities legislation, including the Equality Act 2010.
The FCA has already extended, with effect from 20 April 2022, the Handbook rule DTR 7.2.8AR. This previously required in-scope companies to disclose in their corporate governance statement the diversity policy applied to their board, or to explain where no such diversity policy is applied. The new rule extends this to cover the diversity policies of key board committees, and to indicate that reporting on board and board committee diversity policies could consider wider diversity characteristics, including age, education, and professional backgrounds.
The new rules will apply to accounting periods starting on or after 1 April 2022, so firms should be fully complying from this date, albeit the FCA is encouraging companies whose financial years began on or after 1 January 2022 to consider reporting on the targets and making numerical disclosures in relation to their current accounting period on a voluntary basis. The new rules will be reviewed in three years’ time.
We consider that the arguments for greater representation of women and increased diversity on company boards are well-made, evidence-based, and compelling. We believe that increased transparency is a good thing. It should enable those firms that genuinely take these matters seriously to demonstrate real progress to their stakeholders and attract long term investment. Conversely, the 'comply or explain' rules should help to shed light on those companies that are yet to fully buy-in to the need for change, so that investors - and the wider public for that matter - can take an informed view as to whether they want to be associated with these firms. The FCA’s new requirements should help to further nudge the diversity dial in the right direction.
As regulators begin to pay more attention to diversity and inclusion at an executive level, firms are going be held to account for how they structure and manage their senior leadership teams. If D&I is not already at the heart of your board and executive agenda, it’s vital that it is – the time to act is now.