Diversity and Inclusion: Clear transparency?
It is clear that transparency can drive as well as demonstrate change, but when the spotlight is being shone on areas that are less clear caution and context are crucial. The FCA published its Consultation Paper on diversity and inclusion on company boards and executive committees in July (CP21/24), with the 12 week consultation closing on 20 October 2021. This briefing considers the consultation and seeks to set it into context.
Diversity and inclusion are important, both as drivers for a fairer society and to improve the functioning and governance of companies through avoiding ‘group think’ and its associated issues. They are therefore important parts of the “S” and “G” in “ESG”; Victoria Younghusband looks separately at developments in the “E” in ESG - do your priorities need to change with a changing landscape?
The consultation proposes changes to the Listing Rules to provide for disclosure in annual financial reports, by both UK and overseas companies with a premium or standard listing, on whether they have met specified targets for diversity in their board composition - to include numerical data on the gender and ethnic diversity of members of their board and senior management.
In addition, the FCA proposes extending the requirements relating to the inclusion of companies’ diversity policies within their corporate governance statements under the Disclosure Guidance and Transparency Rules (DTRs).
There are already other reporting requirements in relation to gender balance, such as the requirements for quoted companies preparing strategic reports to include a breakdown showing the number of persons of each sex who are directors, senior managers, and employees (section 414C of the Companies Act 2006) and the requirement for large companies to report annually on their gender pay gap (Equality Act 2010 (Gender Pay Gap Information) Regulations 2017 (SI 2017/172)).
The FCA refers to moves to promote greater gender diversity in the US, Hong Kong, Singapore, and Australia. It also refers to the Davies Report and Hampton-Alexander Review on women on boards and various changes within the UK Corporate Governance Code to provide that diversity should be considered in the appointment, succession, and evaluation of the board.
The form in which the FCA proposes that gender diversity data be disclosed is a table, in the prescribed format, with the choice of four boxes to be completed;
- men (including individuals who identify as men);
- women (including individuals who identify as women);
- non-binary; and
- not specified/prefer not to say.
The data would therefore be different from, for example, the data in the breakdown by sex currently required for strategic reports.
The prescribed format for ethnicity reporting has six boxes, also including “other ethnic group” and “not specified/prefer not to say”.
The data for ethnicity reporting is arguably less clear. The FRC’s report on board diversity and effectiveness in FTSE 350 companies in July 2021 highlighted that the chair of the board should be responsible for driving inclusion, but that change takes time and there should be a focus on collecting data across the various elements of diversity. The Parker Review into the ethnic diversity of UK boards was commissioned by the Government back in 2015 and published its final report and recommendations in 2017, with update reports published by the Parker Review Committee in February 2020 and March 2021.
There are various definitions and classifications of ethnicity. CP21/24 focuses on non-white ethnic minorities using the categories recommended by the Office for National Statistics. However, this does create issues when applied to companies with overseas operations. The Parker Review noted that the nature of international organisations “creates a local versus global tension with implications for terms like “minority” which are relative, localised and contextual”. There is also no legal obligation for individuals to disclose which group (however defined) they identify with (ignoring data protection and other issues around collecting the data). BEIS have indicated that in its testing following its 2018 ethnicity pay reporting consultation it has found a number of difficulties in designing a methodology to produce accurate figures; a formal response to the 2018 consultation has not yet been published.
Broadly, CP21/24, which followed the joint FCA/PRA discussion paper on diversity and inclusion within the financial services sector (see DP21/2), proposes that, with effect from accounting periods beginning on or after 1 January 2022, companies with a premium or a standard listing should include the following in their annual reports:
- a comply or explain statement on achievement of a certain gender and ethnic minority targets as demonstrated in the gender and ethnicity tables, being that at least: (i) 40% of the board should be women; (ii) one of the senior board positions (Chair, CEO, SID or CFO) should be a woman; and (iii) one member of the board should be from a non-white ethnic minority background; and
- a standardised numerical disclosure in tabular format on gender and ethnic diversity for the board and the executive management team.
The FCA also proposes an amendment to the requirements relating to the inclusion of the company’s diversity policy within its corporate governance statement (under Rule 7.2.8A R of the DTRs), to extend the policy to the remuneration, audit, and nomination committees and add specific references to ethnicity, sexual orientation, disability, and socio-economic background, in addition to the current references to age, gender, educational and professional backgrounds. Companies have the option, where appropriate, to include numerical data on the diversity of the board and its committees.
Whether or not the FCA will achieve its aim of better company disclosure on diversity remains to be seen. There are also particular issues when reporting on diversity for small data sets, such as boards, to the extent that individuals do not wish to be personally identified. Reticence to be identified may be overcome by the pressure for boards to set an example, but that may add unfavourably to the existing pressures of being a director in a listed company or lead to inaccurate reporting if individuals are reluctant to be open about personal characteristics.
Many of the potential issues could potentially be addressed through broadening the application of the “comply or explain” principle to the proposals to allow companies to adapt their reporting to their specific situations, whilst being required to explain why they have taken the particular approach they have determined to be most appropriate.
The FCA aimed to publish final rules by late 2021 but has had a large number of responses. Given the importance the FCA places on diversity and inclusion in its ESG Strategy, it is clear that there will be rules, but it is to be hoped that there may be some changes from the draft rules set out in the consultation and that the additional transparency introduced does achieve the desired outcomes.
This article is part of our biannual Public Company Update – sign up to receive this newsletter by clicking the subscribe button on the right. For more information on the above please contact your usual Charles Russell Speechlys contact.