The FCA publishes policy guidance on diversity-a bold initiative but will it work?

Last month, the FCA published PS22/3 heralding changes to the Disclosure Transparency Rules and the Listing Rules designed to benefit investors by improving transparency about board and executive management diversity.

For accounting periods starting on or after 1 April 2022, listed companies (broadly, UK and overseas issuers with equity shares, or certificates representing equity shares, having a premium or standard listing) must include in their annual reports a statement, on a “comply or explain” basis, of compliance with diversity targets for board and senior management roles.

In summary, the targets are:

• At least 40% of board roles should be filled by women
• At least one senior board position (Chair, CEO, CFO, SID) is female
• At least one board member represents an ethnic minority (defined by reference to ONS recommended categories)
• A table of numerical data on sex, gender ID or ethnic diversity among board and senior management positions (Chair, CEO, CFO, SID and executive management positions).

The FCA’s aim, to increase transparency for investors and to drive progress on diversity, equality and inclusion (DE&I) following on from the Hampton-Alexander and Parker reviews, is to be applauded.

DE&I raises a number of sensitivities, however, and, in its attempt to navigate through those sensitivities whilst keeping an eye on its goal, there is a risk that the FCA’s approach may achieve neither the clarity nor progress it seeks.

The FCA states that it is not setting quotas, yet the first three targets summarised above look suspiciously like minimum quotas, despite being described as providing a “positive benchmark” for issuers to report against on the basis of comply or explain. The FCA expects that investors may use the information disclosed in compliance with PS22/3 to engage more with companies on greater diversity and inclusion.

The principle of “comply or explain” in wider UK corporate governance culture works well generally. It recognises that one size cannot fit all and is infinitely preferable to a prescriptive set of standard disclosures. But to be fully effectual, it requires flexibility and a positive commitment by both issuers and investors to communicate and understand each other’s position. In our experience, companies find that engagement does not work if investors, pressed for time, focus on compliance with the letter but not on the explanations for non-compliance. To work efficiently, engagement requires companies to present their story and investors to listen to and consider the arguments. There may be more work to do on both sides.

In the meantime, the potential risk is that the “positive benchmark” sought by the FCA becomes the recognised minimum acceptable position for investors, which might place some issuers (including private companies planning an IPO) at a disadvantage when seeking to raise capital or planning the transition from private to public ownership. Potentially, therefore, the FCA’s policy statement contains implications for unlisted companies, too.

Perhaps of more relevance to the pursuit of clarity and consistency of reporting is the flexibility for issuers to choose an approach to reporting on sex, gender and ethnicity, which reflects their individual approach to data collection. A standardised table format is included in an annex to PS22/3. The FCA’s view is that investors and others will be able to use the information to assess and compare board and executive management diversity. But, unless data is, in practice, collected and presented in a consistent form, there is a risk that the outputs may not represent reality and may not be as useful to investors as intended.

The FCA recognises this. The first of its two measures of success is the fullness and clarity of the data generated by compliance with PS22/3. Whether the data provided is comparable and meaningful will be assessed by the FCA, which plans to review its DE&I policy statements in three years’ time.

The FCA’s second measure of success is feedback from investors and others about whether the data provided by issuers is useful. It is to be hoped that investors engage fully in this process and provide their considered feedback.

DE&I is an important issue for companies and society and the statistics show that more (and faster) progress is needed. For any readers wondering why the FCA is focusing on DE&I at a time when there are other major issues relating to financial conduct to address, there might be a clue in the work the FCA is doing, jointly with the PRA, to improve diversity and inclusion in the financial services sector. Companies in other sectors may also need to change their approach to board and senior management appointments. It is likely as is the case in relation to wider ESG topics, that DE&I will rise up the agenda for engagement discussions with investors.

To discuss or comment on this article, please contact Paul Norris.

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