Beyond tone from the top - embedding D&I within governance
03 March, 2022
Following a discussion paper (DP) from the FCA and PRA last year setting out a range of potential proposals to improve diversity and inclusion (D&I) in financial services (FS), the regulators have made clear they expect firms to consider the themes of the paper and where they can make progress.
As firms wait for the follow-up consultation (due in the first half of this year), many are assessing their gaps and the levers they can use to effect change. Governance and accountability will be a key driver of change - so what steps should firms be considering, to prepare for the policy direction the regulators are heading in on D&I, and to meet regulatory expectations more broadly?
The regulators have long extolled the importance of the tone from the top in driving the right culture within firms. But the regulators are now looking for FS leaders to embrace a more fundamental change - to ensure their business reflects the society they serve, and to design inclusive products and services that improve consumer outcomes. While the ideas set out in the DP have not yet evolved into formal proposals, the direction of travel from the regulators on D&I is clear, and will require leaders and boards to do much more than set the right tone.
Improving diversity at senior levels
The regulators state in the DP that a firm’s board must be diverse in itself, and take ultimate accountability for ensuring the firm is inclusive and diverse. To help ensure the former, the regulators are considering introducing board representation targets for a range of diversity characteristics and for a wider range of firms (significant banks and investment firms already have to set a target for gender at board level).
While the industry has made major strides on D&I in recent years, improving diversity at the most senior levels remains a challenge and will take time. Meeting board representation targets would require firms to make a concerted effort to recruit more board members with diverse backgrounds or experiences, by creating a more diverse pipeline, and by including diversity within board policies and processes. Boards need to understand the skills, experience and background of their current members to effectively recruit to address any gaps. This could be achieved through a framework of required skills and competencies which board positions are filled against. Other steps firms can take include rooting out biases across the employee lifecycle, looking at recruitment processes, the talent pipeline, identifying actions on progression and attrition, and ensuring the talent pool they recruit from is as wide as possible.
Only by improving diversity at every level of a firm, will businesses be able to meet the regulators’ expectations in other areas too. For instance, firms need to be sufficiently diverse and inclusive to recognise and respond to the diverse needs of their customers, and therefore to meet the FCA’s expectations on the fair treatment of vulnerable customers and its proposals for a new consumer duty.
Clear accountability
In terms of responsibilities, the regulators suggest in the DP that boards should be responsible for setting a D&I strategy, overseeing its progress, and holding management to account for promoting diversity and an inclusive culture. In our view, the chair of a board has a key role to play in holding the executives to account on D&I issues, requesting regular reporting and progress against KPIs, building D&I into succession planning, and ensuring D&I is considered explicitly in relation to representation and wider business decisions.
In addition to the collective responsibility of the board, the regulators discuss the possibility of making senior leaders more directly accountable for D&I. They discuss making it explicit under the Senior Managers & Certification Regime (SM&CR) that the prescribed responsibility for culture (typically allocated to chairs and CEOs) includes responsibility for implementing and executing the firm’s D&I strategy. The regulators also raise the possibility of linking performance against D&I objectives to variable remuneration for all Senior Managers with responsibility for managing employees.
We believe that senior accountability will play a fundamental role in driving D&I improvements across the industry, by providing clarity on responsibilities and creating incentives for Senior Manager Functions to drive change. Clear articulation and consistent support for improvements in D&I from senior leadership is a prerequisite for driving change and fostering buy-in for diversity and for inclusive culture and behaviour.
However, good data would be necessary to show that these responsibilities are being met - and as we explore in our previous blog, firms face a number of data-related challenges which would need to be addressed (our report with the Investment Association looks at how firms can overcome some of these challenges to effectively collect and analyse diversity data).
Many firms already link remuneration of senior management to progress on D&I as well as broader Environmental, Social and Governance (ESG) issues. Generally, such firms have been able to demonstrate progress against their medium to longer term D&I and ESG targets. We explore the complexities of linking executive pay to D&I and other ESG metrics in more detail in this report, which shows that 60% of FS companies in the FTSE 100 include an ESG measure in executive pay.
Finally, firms need to consider how they embed D&I accountability and values throughout the organisation, to middle management and other staff. Meaningful and ongoing D&I training is a key aspect of ensuring all staff understand what role they have to play in fostering an inclusive environment.
As firms continue to progress their work on D&I, it’s clear that governance and accountability will be a key driver of change. Businesses should use the time between now and the regulators publishing more concrete proposals, to assess what steps they can take to further improve diversity at senior levels, to strengthen leadership and accountability on D&I, and to disseminate the right culture throughout the organisation.
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