January 6, 2022
Estimated reading time: 6 minutes
Could senior leaders’ pay be linked to diversity and inclusion measures?
Financial regulators in the UK – the Financial Conduct Authority (FCA), the Prudential Regulation Authority (PRA) and the Bank of England (BoE) – have published a discussion paper aimed at improving diversity and inclusion across regulated firms.
The discussion paper explores a number of policy options, the most interesting of which could hold senior leaders directly accountable for the diversity within their firms, or see their remuneration linked to diversity and inclusion metrics.
The discussion paper follows a string of environmental, social and governance (ESG) messages from financial regulators across the globe as such issues “are rising to the top of the agenda for corporates, investors and wider society”. These are messages that not only look to ensure that financial services are proactively working to improve and be accountable for the effect that they have on society, but that look to ensure such companies are disclosing related data too.
It is against this background that the regulators have released this discussion paper, noting that they “need to make our expectations of firms clearer and to root them in our statutory objectives, supported by the Public Sector Equality Duty introduced by the 2010 Equality Act.”
How will regulators look to manage diversity and inclusion?
The paper sets out that the regulator’s goals are ultimately “to see increased diversity and inclusion in financial services translate into safer and sounder firms with better internal governance and risk management, a more innovative industry, and financial products and services that meet the diverse needs of consumers.”
In advancing that goal, the regulators have set out a number of considerations, including:
- Data collection and reporting for ongoing monitoring. The regulators are considering introducing regular disclosure reporting, in relation to employee data, to understand the state of play, monitor progress, identify barriers, and implement “the most effective interventions”.
- Introducing firm-wide diversity and inclusion policies. Diversity and inclusion should be a central consideration from all firms, with these principles trickling from the top (board level) down. The FCA is exploring the requirement for all firms to have a diversity and inclusion policy, which would need to be displayed on a company’s website.
- Diversity requirements similar to NASDAQ. NASDAQ has introduced listing rules, which will require all companies listed on its US exchange to have, or explain why they do not have, at least two diverse directors. The UK regulators are toying with the idea of considering similar requirements.
- Linking progress on diversity and inclusion to remuneration. The regulators believe this could be a “key tool” for driving accountability in firms and to incentivize progress. It is considering a future environment whereby all senior managers who have responsibilities for managing employees should expect their performance against diversity and inclusion objectives to be reflected within their bonuses.
Why is diversity an issue for financial regulators?
For an industry that is often seen to lack diversity, the regulators’ proposed measures may fall flat. It is likely that, as with proposed climate-change regulations or previous discussions around culture and conduct, some may ask how diversity and inclusion falls within the remit of financial regulators.
This is a topic that FCA CEO, Nikhil Rathi addressed in a recent speech, in which he pointed out that research showed “greater gender diversity improves risk management culture and decreased the frequency of European banks’ misconduct fines”. He added that the chief concern among financial regulators is that a lack of diversity at the top of business could point to a firms’ inability to understand the different communities that they serve.
In the same speech, he added that McKinsey research found that the most diverse companies outperform the least diverse by 35%, and that US investors are increasingly moving so that they will only underwrite IPOs where the company has at least one diverse board member. In some cases, this is raised to two. This makes diversity and inclusion a good business case, too.
As Deputy Governor of Financial Stability at BoE, Sir Jon Cunliffe highlights:
Diversity and inclusion is beneficial for financial stability. Groupthink and overconfidence are often at the root of financial crises. Enabling a diversity of thought and allowing for an array of perspectives to coexist supports a resilient, safe and effective financial system.
Ultimately, there is a growing line of thought that a lack of diversity and inclusion within firms not only tends to “weaken the quality of decision-making” but is suggestive of a broader culture that fails to fit in with, or understand, the diverse needs of the society it serves.
What next for diversity, inclusion and financial regulation?
The regulator’s paper is open until 30 September 2021, after which – as a starting measure – the regulators are proposing to collect data from firms about their workforce, in a one-off pilot survey towards the end of 2021 to build upon existing proposals.
In many ways, the regulator’s proposals leave me torn. Diversity and inclusion is, of course, hugely important both societally and within the workforce. It is also hugely topical, with recent events in both the UK and the US bringing a lack of diversity, inclusion and tolerance to the fore. Within financial services – an area renowned for its lack of diversity and social inclusion – it is particularly critical. However, the introduction of measures that link this with pay or investor interest will undoubtedly prove controversial.
There is, of course, the argument that hires should be made on merit and ability, rather than because senior leaders have been incentivized to make that hire. That leads to a broader question though – how far are our perceptions of ‘ability’ and ‘merit’ rooted in unconscious biases? Perhaps we are making decisions on who is most able or suited for a job with a foundational bias in mind – one that we are not aware of.
That said, perhaps linking pay with diversity and inclusion may not be the best way forward. Maybe hires should instead be made with blind CV’s or portfolios in mind, so only those who have performed the best are promoted or appointed.
Overall, progress towards diversity and inclusion is not just welcomed, but needed. If senior managers and the board need incentivizing initially to encourage a culture of inclusion – so be it. The hope is, I suppose, that the greater diversity we see at the top of business, the fewer barriers and biases there will be to making these hires in future. Incentives are a starting point until we reach a place where the companies we work in are reflective of the societies we live in. Only then will such incentives be rendered superfluous.
Opinion aside, the regulator’s Discussion Paper will inevitably lead to further regulatory scrutiny and greater obligations for financial services organizations, which will build upon emerging regulation and disclosure requirements for environmental, social and governance (ESG). Like it or not, firms should begin preparations to meet these emerging regulations head-on.