Requirement to set targets
The Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) are proposing that all large firms will be required to set and publish “stretching but realistic” targets for improving diversity.
The FCA’s proposals would apply to all “large firms” (i.e. firms with 251 or more employees) with Part 4A permission under the Financial Services and Markets Act 2000 (excluding Limited Scope SMCR firms). Similarly, the PRA’s proposals would apply to CRR and Solvency II firms (including third country branches) with 251 or more employees who are predominantly carrying out activities from an establishment in the UK.
Nature and basis of targets
There is some divergence between the PRA and FCA proposals as to what demographic characteristics should be covered by firms’ D&I targets. The PRA expects firms, at a minimum, to set targets for women and ethnicity, if the firm identifies underrepresentation in these areas. By contrast, the FCA does not mandate which demographic characteristics firms’ targets need to cover.
Subject to the specific reference to firms having gender and ethnicity targets within the PRA’s proposals, the regulators do not generally intend to mandate new targets for firms, recognising that a ‘one-size-fits-all’ approach is unlikely to be appropriate given the breadth of firms covered by the proposals and their different circumstances. Instead, firms need to decide appropriate targets for themselves. Those targets should align with the firm’s D&I strategy, be informed by their current diversity profile and consider the diversity profile of the UK population and the specific geographical area in which they operate.
Building on existing requirements
These proposals are in addition to the obligations that already apply to certain firms. The FCA already requires listed firms to include a statement within their annual financial report setting out whether they have met specific board diversity targets on a ‘comply or explain’ basis. Those targets for listed firms are prescriptive, namely:
- at least 40% of the board are women;
- at least one of the senior board positions (Chair, Senior Independent Director, CEO or CFO) is a woman; and
- at least one member of the board is from a minority ethnic background.
Similarly for PRA-regulated firms, a firm that has a nominations committee must currently ensure that the committee “decides” on a target for the representation of the underrepresented gender in the management body and prepares a “policy” on how to increase the number of the underrepresented gender in the management body in order to meet that target. The language of this requirement is also subject to change under the proposals – the nominations committee would instead “recommend” a target to the board, and prepare a “strategy” for how to increase representation of the underrepresented gender.
The regulators’ proposals expand the requirements on firms to set diversity targets more widely within their organisations, with in-scope firms required to set diversity targets for (i) the board; (ii) senior leadership; and (iii) the employee population as a whole. In particular, the regulators are clear that they see the focus on diversity within the wider employee population as being a key driver for diversity at the most senior levels of the organisation given the drops in gender and ethnic diversity as individuals progress through firms. If firms are losing diverse talent before they reach senior leadership positions, they need to understand why and take steps to rectify the situation.
How to set targets
Firms will need to think carefully about the targets they set themselves and what those targets are based on. This is particularly the case given the proposed public disclosure obligations (set out in greater detail below).
As a starting point, firms will need to have a strong understanding of the demographics and diversity of their workforce (including their board and senior leadership). This will likely rely in large part on the diversity data the firm holds in respect of its employees, for example to determine the number of women or individuals from a minority ethnic background at different levels of seniority within the business. Firms should avoid making assumptions about areas of underrepresentation, particularly given the proposed requirement that they publicly disclose the rationale for the D&I targets they have set. Of course, where a firm only has limited demographic data in respect of its workforce, it may first need to take steps to build trust with employees, so that they feel more comfortable providing diversity data to the firm. This could be, for example, through messaging from senior leadership emphasising the importance of D&I for the firm, and the steps the firm is taking to make improvements. This will also involve important data protection considerations, which we will consider in a later instalment in this series.
In addition to numerical data, firms are encouraged to utilise their own employee networks and affinity groups to help identify areas of underrepresentation and weakness and to inform areas that might benefit from specific targets. Firms will need to be sensitive to affinity groups’ purpose and terms of reference in seeking their views on these areas.
In setting targets, firms will also need to take care not to stray into unlawful positive discrimination. While aspirational targets will generally be a lawful means of promoting D&I (and, indeed, required of firms if the regulators’ proposals are implemented), the more such targets come to resemble mandatory quotas (for example, by imposing penalties if the target is not met), the higher the risk that they are seen as unlawful discrimination.
The regulators expect targets to be “stretching but realistic”, and firms will need to strike a balance between unachievably ambitious targets (the failure to meet which may need to be explained to the regulators and/or other stakeholders), and targets that are too cautious and risk being viewed as artificial, or only paying lip service to the need for greater diversity and inclusion.
Reviewing targets
The proposals do not mandate how frequently firms need to update their targets. Firms are expected to actively monitor the targets they have set for themselves to ensure that they remain stretching but realistic and to assess whether additional or amended targets are required for other underrepresented characteristics. Given the requirement to disclose targets annually (as set out on greater detail below), it would be sensible to review targets on at least an annual basis even if ultimately they are not updated.
Ultimately, the firm’s board will bear responsibility for overseeing diversity targets, including monitoring progress against targets, identifying obstacles to achieving them, and agreeing plans to overcome those obstacles. Contrary to the proposals initially mooted by the regulators in their discussion paper, there will be no specific individual within each firm individually accountable for progress against D&I targets, however, the board and senior managers responsible for D&I would be expected to be able to explain the rationale for the targets that have been set.
Disclosure of targets
The regulators propose that firms would be required to publicly disclose their D&I targets on an annual basis, alongside the firm’s rationale for selecting those particular targets and the progress over time made towards those targets. This is for the explicit purpose of improving transparency and allowing the regulators and other third parties to benchmark firms’ progress against their peers. While a failure by a firm to achieve its targets would not in itself be considered a failure to comply with the proposed rules on targets, firms should be able to explain why the target was not met and what they are doing to address this (including targeted interventions, or amendments to the targets).
The FCA has provided more granularity on the information that it proposes firms provide in relation to their D&I targets. That information includes:
- the demographic characteristics they have set targets for, as well as any (voluntary) inclusion targets;
- the percentage at which each target has been set;
- the year each target was originally set;
- the year the firm is aiming to meet the target;
- the firm’s current level of representation against each target (as a percentage);
- the rationale for the targets set; and
- any further information the firm would like the FCA to consider about the targets the firm has set.
The proposals on setting D&I targets are ambitious and will require firms to create a workplace culture that encourages employees to disclose sensitive personal information and engage with the firm’s D&I strategy. Firms will need to approach the exercise of setting targets with care, particularly given the additional disclosure obligations proposed by the regulators. In our next post, we consider those disclosure obligations in greater detail.
Special thanks to Zoe O'Logbon, trainee at Allen & Overy, for her contribution to the drafting of this post.
