FCA unveils proposals for improving diversity and inclusion in the financial services sector

Posted: 17/10/2023

In September this year, the Financial Conduct Authority (FCA) published its long-awaited consultation paper, Diversity and inclusion in the financial sector - working together to drive change. The FCA’s consultation paper was published alongside one from the Prudential Regulation Authority (PRA). 

The regulators consider that greater levels of diversity and inclusion (D&I) can improve outcomes for markets and consumers and support the integrity and competitiveness of the UK’s financial services industry. The current focus on culture comes out strongly in the paper. The dangers to consumers of poor decision making through ‘groupthink’ in a non-inclusive workforce are set out. Discrimination is seen not only as an unacceptable workplace practice but something which, if left unchecked, can lead to further wrongdoing and harm to clients. 

Indeed, the PRA’s proposals, published on the same day, state that discrimination and harassment have the effect of hindering individuals from speaking up and providing an effective challenge as part of a firm’s decision-making processes. The FCA refers to enhanced ‘psychological safety’ and a culture of speaking out as being crucial to a well-managed firm.

The consultation paper is an acknowledgement from the FCA that, despite some promising signs, there is more to be done to improve D&I in the financial services sector. The proposed new regulatory framework includes additional reporting requirements for larger firms (more than 250 employees), and changes to the assessment of honesty, integrity and reputation, with a greater emphasis on non-financial misconduct. The proposed changes to the FCA Handbook are set out in appendix 1 to the consultation paper.

Non-financial misconduct

The FCA is proposing a minimum standard for all FSMA firms with a part 4A permission, with the aim of reducing discrimination and misconduct in the sector. 

Perhaps one of the more significant changes will be the explicit inclusion of non-financial misconduct in the following areas of the FCA Handbook: the FCA’s conduct rules (COCON), the ‘fit and proper’ test section (FIT 2), and the suitability threshold condition in the threshold conditions section (COND). The FCA believes that some firms already take non-financial misconduct into account, while others do not, and that it is therefore important to establish a clear framework to ensure consistency.

Conduct rules

The FCA is proposing to expand the scope of the COCON sourcebook to make clear that it covers serious instances of bullying, harassment and similar behaviour towards fellow employees. Examples of what constitutes serious misconduct and will breach the conduct rules, and what is out of scope as it relates to an employee’s personal or private life, will be provided in additional guidance.

Fitness and propriety

Currently, firms must be satisfied, on an ongoing basis, that relevant individuals are ‘fit and proper’ to carry out their role. The FCA proposes to make it clear that bullying and similar misconduct within the workplace are relevant to fitness and propriety, and that similarly serious behaviour in a person’s personal or private life is also relevant. Currently an individual may carry out serious non-financial misconduct outside the workplace, for example, a sexually motivated offence, yet could arguably still satisfy the ‘fit and proper’ test. This will no longer be the case under the new proposals.

Additionally, the changes will clarify that conduct that could damage public confidence in the UK financial system may affect fitness and propriety.

Suitability threshold condition

There will be an extension to the guidance on the suitability threshold condition in COND to include, for example, sexually or racially motivated offences, or findings that a firm, or connected person such as a director, has engaged in discriminatory practices.

Other changes

The consultation paper also proposes further changes for firms with over 250 employees. Whether or not a firm meets the large firm threshold will be assessed on the average number of employees over a rolling three-year period, at a specified annual reference date. The new requirements include the following:

D&I strategy

Firms in scope must develop a D&I strategy, which will be overseen by the board. The strategy, which should contain information about the firm’s objectives, a summary of arrangements in place, and a plan for meeting goals and measuring progress, must be easily accessible, such as available on the firm’s website.

Targets

In-scope firms will be required to set targets to address underrepresentation. Firms will normally be expected to set three targets, one for the board, one for senior leadership and one for the workforce as a whole. Firms will have flexibility over the targets they set, and when they should be reviewed. Under the new rules, firms will be required to publicly disclose their targets and their progress towards them on an annual basis.

Firms should, however, be aware that the Equality Act 2010 permits so-called ‘positive action’ only in limited circumstances. When identifying targets, firms should take care to avoid inadvertently discriminating against those who do not share the protected characteristic that is the subject of the target. For example, setting a target to increase the number of women across the workforce could lead to a claim by an unsuccessful male candidate that they have been subject to sex discrimination. It is important that any targets are backed up by evidence that the targeted group is genuinely under-represented, and any recruitment decisions are clearly documented.

Data reporting

Firms will be required to collect and report, on an annual basis, numerical data across a range of demographic characteristics, inclusion metrics, and progress against the targets they have set (above). This will enable the FCA to compile an industry D&I report, in order to carry out trend analyses, identify areas for improvement, and drive progress.

Some data reporting will be mandatory, whereas firms are encouraged to report other data on a voluntary basis. Mandatory demographic characteristics are:

• age;
• sex or gender;
• disability;
• ethnicity;
• religion; and
• sexual orientation.

Firms may also choose to report on both sex and gender, gender identity, socio-economic background, and parental and carer responsibilities.

Note that the reporting requirements do not exactly correspond with the nine ‘protected characteristics’ under the Equality Act. For example, there is no requirement to report on the protected characteristics of pregnancy and maternity or marriage and civil partnership. Similarly, the requirement is to report on data relating to gender identity, and not the protected characteristic of gender reassignment. Socio-economic background is not one of the protected characteristics.

Firms are also required to report on a range of inclusion metrics, gathered by way of employee surveys as to whether they feel:

• safe to speak up if they observe inappropriate behaviour or misconduct;
• safe to express disagreement with or challenge the dominant opinion or decision without fear of negative consequences;
• their contributions are valued and meaningfully considered;
• they are subject to treatment that had made them feel insulted or badly treated because of their personal characteristics;
• safe to make an honest mistake; and
• that their manager cultivates an inclusive environment at work.

Data on inclusion must be captured on an anonymous and voluntary basis, with employee surveys carried out on a five point scale from ‘strongly agree’ to ‘strongly disagree’, including a neutral option, and an additional option of ‘prefer not to say’.

In relation to data on target setting and progress, it is proposed that firms provide information on:

• the demographic characteristics for which they have set targets;
• the percentage at which each target has been set;
• the year the target was originally set;
• the year the firm aims to meet the target;
• the current level of representation against each target (expressed as a percentage);
• the rationale for the targets set; and
• any further information they would like the FCA to consider.

It is proposed that data is reported in the same three categories as used for the targets, namely board, senior leadership, and whole workforce.

Next steps

The consultation will be open for responses until 18 December, and a policy statement is expected sometime in 2024, once feedback has been considered. The rules will come into force 12 months after the date on which the final rules are published, which will be the reference date for reporting purposes. Firms will then have a three-month window to file their report, which will be done using a single data return on the RegData platform. A sample reporting template is available to download from the FCA website for illustrative purposes.

While the changes are still merely proposals, and will not be in force for some time yet, what is clear is that there will be a renewed focus on non-financial misconduct, including discrimination, and misconduct that relates to an individual’s personal or private life. Hopefully, firms will not consider the type of legal challenge threatened in the summer by Crispin Odey’s legal team, namely that the FCA is failing to demonstrate how workplace allegations of sexual misconduct harm the integrity of financial markets. What is also clear is that firms will need to review and build on their existing methods for data retention, and may wish to consider implementing new systems now, to enable them to meet the new reporting requirements reporting when they are in place.

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