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PRA urges boards to diversify

11 March 2020: the Prudential Regulation Authority (PRA) has sent a letter to Solvency II insurers, large non-directive firms and capital requirement regulation firms, to stress the importance of boardroom diversity.

The regulator has used the communication to issue a stark reminder for all parties to comply with its rules on the issue.

The letter highlights how diverse boards “made up of members with different skills, knowledge, experience and values, will support divergent perspectives on business operations and risk strategy”. Adding that this reduces the risk of “groupthink”, which can negatively impact the “safety and soundness of PRA-regulated firms”.

The PRA drew attention to the European Banking Authority’s February 2020 report on the benchmarking of diversity practices, which showed that 70% of its sampled UK credit institutions and investment firms now have a policy in place for promoting diversity on the management body. While a substantial improvement on 2015, when just 15% had such a policy, “compliance remains far from universal”.

ICAEW’s report 'Information overload: effective boards and committees in financial services' looks at structural and practical ways that boards and increase diversity through adapting their ways of working and presenting information.

Zsuzsanna Schiff, Manager in ICAEW’s Financial Services Faculty and author of Information Overload believes that unconscious bias – essentially surrounding ourselves with “people like us” plays a part in holding back real diversity. “In specialised industries like banking and insurance bringing diverse candidates to the board can be even more of a challenge due to the perception that subject matter expertise and experience is a prerequisite,” says Schiff. “However, different perspectives help ensure non-executives are asking straightforward questions that may be overlooked by those who are immersed in the field.”

Push and pull factors

In April 2018, the PRA extended such obligations to insurers so that all capital requirement regulation (CRR), Solvency II and large non-directive firms were compelled to adopt a “broad set of qualities and competencies when recruiting to the management/governing body”.

The letter states that financial institutions must  “satisfy themselves” that their firms are meeting the PRA’s brief and to “take remedial action” if not. The regulator has the Senior Managers & Certification Regime at its disposal if firms are not found to be complying with rules.

However, there are many equally compelling and well-documented reasons to increase diversity and inclusion within organisations.

A 2015 McKinsey report, Diversity Matters, on 366 public companies across numerous industries in the UK, Latin America, Canada and the USA, found that companies in the top quartile of gender diversity were 15% more likely to have financial returns above their national industry median. Meanwhile, businesses in the top quartile of ethnic diversity were 35% more likely to have financial returns above their national industry median.

Firms in the bottom quarter for both gender and ethnicity were statistically less likely to achieve above-average financial returns than the average companies in the dataset, meaning that they were not just failing to lead, but were lagging.

The results varied by country and industry. Companies with 10% higher gender and ethnic diversity on management teams and boards in the US, had earnings before interest and taxes (EBIT) some 1.1% higher, while in the UK, firms with the same diversity level had EBIT 5.8% higher.

McKinsey deduced that such unequal performance across companies in the same industry and country implies that “diversity is a competitive differentiator that shifts market share towards more diverse companies”.

Companies with better board diversity are better able to win top talent, improve customer orientation, employee satisfaction, and decision making, leading to a virtuous cycle of increasing returns, the report found.

Diversity should though, reach out beyond gender and ethnicity, to include areas such as age and sexual orientation, as well diversity of experience, all of which are likely to bring some level of competitive advantage to firms that are able to attract and retain such varied talent.

A McKinsey report in 2018, Delivering through Diversity, found progress to be slow. Of the 346 mostly US and UK companies in its 2015 research, average gender representation on their executive teams was up just two points, to 14%, while ethnic and cultural diversity crawled up by a percentage point, to 13%.

In 2019, Koya Leadership Partners’ study, The Governance Gap: Examining Diversity and Equity on Nonprofit Boards of Directors showed that while 96% of the participating organisations saw diversifying their boards as a key objective, less than a quarter (24%) had actively taken any steps to make that goal a reality.

 

Related stories: Genuine engagement needed to tackle lack of ethnic diversity at board level