UK regulator's diversity and inclusion proposals set to shake up financial services

The UK Financial Conduct Authority (FCA) has recently published proposals to increase diversity and inclusion (D&I) in the financial services sector. The consultation period will remain open until 18 December 2023, and interested parties can attend a webinar on 30 October 2023. Publication of the final rules is planned for 2024, with implementation required 12 months later. 

The FCA's position is that diversity is "essential for healthy firm cultures, enabling firms to deliver better outcomes for consumers and markets". The FCA has therefore put D&I at the heart of encouraging a "culture of compliance" as a challenge to behavioural biases and groupthink that arise from monoculture.

The FCA has long advocated improved diversity in the financial sector, particularly in the senior management positions of regulated firms. In July 2021, the FCA, the Prudential Regulation Authority (PRA) and the Bank of England released a discussion paper on D&I proposals, and the regulators have issued a number of statements, reports and speeches since then. 

The PRA simultaneously also published a consultation on D&I, which is relevant to most firms authorised or designated by the PRA. The PRA describes the proposals as having been developed "in parallel" across the two regulators. Nevertheless, there are some differences in approach; for example, in relation to senior manager responsibility for D&I.

FCA's desired outcomes

In the current consultation, the FCA is making rule-based proposals to codify their position, accelerate the pace of change on D&I and support the Consumer Duty. These include ensuring that firms consider the needs, characteristics and objectives of their customers.

Specifically, the FCA has outlined the following desired outcomes: support and promote a healthy culture; reduce groupthink; unlock new talent; and ensure firms have a greater understanding of and provision for diverse consumer needs.

Affected firms

The FCA is proposing a minimum standard requirement on non-financial misconduct (NFM) for all Financial Services and Markets Act-regulated firms with a part 4A permission; and additional requirements for firms with 251 or more employees, including data reporting, D&I strategies, data disclosure, target setting, and risk and governance requirements.

To determine firm size, the FCA will require all relevant firms to report employee numbers annually on FCA's RegData. Employee numbers will be calculated from the average number of employees over a rolling three-year period. The additional requirements would not apply to limited scope Senior Managers and Certification Regime firms, regardless of size.

Non-financial misconduct

The rules on NFM will apply to all relevant firms, regardless of size. This includes behaviour such as bullying, harassment and discrimination.

These changes would be the first time that such rules will be incorporated into the FCA's rules and guidance and represent a potentially significant expansion of the FCA's powers to determine whether individuals are "fit and proper" persons, or whether firms meet the "threshold conditions" allowing them to be authorised firms at all.

The FCA proposals will amend the FIT (fit and proper test for employees and senior personnel), COCON (code of conduct) and COND (threshold conditions) parts of the regulator's handbook. However, if a firm is not already in scope of these rules, the new FCA proposals will not apply.

Additional requirements for larger firms

The FCA proposal requires firms with 251 employees or more to:

• Develop an evidence-based D&I strategy including objectives and goals with a plan for meeting those and measuring progress.
• Collect and report data in numerical figures against a range of demographic characteristics, including average number of employees, age, ethnicity, religion, sex or gender, sexual orientation and disability or long-term health. The recording of other characteristics – for example, gender identity, parental responsibility or carer responsibility – will be voluntary, although the FCA has said that, over time, it expects to see more firms reporting data against these metrics and that it may become mandatory in due course.
• Publicly disclose certain D&I data to increase transparency and scrutiny as well as facilitate comparisons between firms on D&I performance. In line with the collection and reporting of data, some of these disclosures will be voluntary.
• Set appropriate targets across all levels of the employee population to address underrepresentation within the firm. Firms based overseas that carry out operations in the UK would not have to set a target for the area of the firm which is based overseas.
• Consider matters relating to D&I as non-financial risk, and treat these appropriately.

Osborne Clarke comment

Given the number of statements in recent years in which the FCA has stressed the importance of improving diversity in the financial services sector, many of the initiatives contained within this consultation will not come as a surprise to firms. After the significant passage of time since the discussion paper was published in July 2021, the proposed framework will finally provide firms with a structure to better understand the regulatory expectations on them and their management.

For example, many of the concerns from the industry at the time of the discussion paper centred around the administrative burden for firms that would be created by data collection. The FCA said that it has considered the proposals in the context of the relevant data-protection legislation with the Information Commissioner's Office, which had no comments.  

The FCA considers the proposal to be in compliance with the UK General Data Protection Regulation and has built safeguards into the proposal around identifiability, given the granular level of disclosures. It appears that the employee-number threshold is intended to provide a proportionate reprieve from data collection for smaller firms, but the FCA will face an ongoing challenge to ensure it continues to find the right balance for all firms.

However, the potential impact of other proposals, such as the introduction of NFM considerations is highly significant: the rules and guidance being provided to help firms with their assessment of certain conduct, including whether it falls foul of the FCA's standards, makes clear that behaviour in an individual's private or personal life will now be considered as part of the "fit and proper" test for senior management, even where that conduct does not necessarily relate to the individual's ability to provide financial services.  

The FCA's justification for this expansion is the need to maintain public confidence in the financial system and the concern that "serious" misconduct outside the workplace may undermine that confidence. Since the discussion paper, the FCA has made it clear that NFM is "misconduct, plain and simple" and has sought to pursue enforcement proceedings against individuals whose conduct fell below the standards it set. Not all of those proceedings have been successful; however, no doubt contributing to the scope and extent of these rule changes.

While the black-and-white nature of certain criminal convictions, including those that have featured in NFM-related enforcement proceedings to date, may provide the FCA (and firms) with clear evidence of NFM, it remains to be seen how these rules will apply to less clear cut decisions (for example, where allegations are made, but no independent conclusions are reached) or the day-to-day issues faced by firms in deciding outcomes linked to NFM, or whether the FCA is an appropriate body to act as arbiter on moral standards at all.

Nonetheless, the proposals will provide welcome guidance to firms that are struggling to grapple with these issues that historically would not have fallen within the regulators' remit.

There were a number of other more controversial proposals in the discussion paper, including around senior manager accountability and assessment, that have been scrapped entirely, which many firms will welcome.

The consultation contains many proposals, including rule changes and a significant amount of guidance. Although intended to be of benefit to firms, it will take time for firms to digest fully what the proposed "new horizon" looks like and how this will differ between scenarios.

If you would like help navigating the D&I proposals and their impact on your business, please contact our experts.

Amoli Tuli, a Trainee with Osborne Clarke, contributed to this Insight.