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What will make the difference on diversity and inclusion in financial services?

Author: Brian Cantwell

Published: 24 Nov 2021

Firms are past the point of just thinking about diversity and inclusion as investors, regulators and talent add pressure.
The front page of the Times on the 22nd November quoted Girls’ Schools Association president Samantha Price saying parents needed to “keep up” with their children on social justice issues.

Future generations care about the planet, equality, causes and people, said Price.

The takeaway was that culture change is coming from young people on equality, and we should listen – and firms will have to listen too.

The present intentions of regulators on diversity and inclusion will become expected practice, as Gen Z and successive generations below it move into work and start investing in the world.

Investor pressure and data

Firms are past the point where diversity and inclusion are lip-service add-ons to operations and strategy.

Gurpreet Manku, Deputy Director General at the British Private Equity & Venture Capital Association, told ICAEW that diversity and inclusion’s principles had already landed with private firms.

"I don’t need to justify or make the business case for it” she said. “Firms have long moved onto how to install practices to aid diversity and inclusion; what they need to do it and what efforts they can make.

“This includes policies on hiring, retention of women in the industry and in firms from a junior level.”

Manku said a key area within private capital firms was data collection for reporting, which crystallised diversity and inclusion sentiments into numbers to show to investors.

She said institutional investors, pension funds and endowment funds all ask about PE funds’ approach to diversity and inclusion.

"It isn’t just venture capital and private equity firms that are asking for diversity and inclusion data; it is their own investors too. And so the data is really important, crucial even.

“On investment they’ll also want to see data on their underlying portfolio companies: so the data collection process is extensive.”

Data and investor pressure is the start, but baking in inclusion is the key. “It’s your policies around people once they’re hired; the policies and how you approach mentoring and promotions internally. This needs to be thought about if you want diversity to be a permanent feature,” adds Manku.

Regulatory drivers

In the UK, the Financial Conduct Authority (FCA) is proposing to change listing rules for businesses, which will require companies to meet diversity targets, and publish diversity data on their boards and executive management. ICAEW has responded to this consultation.

The FCA’s key points are:

  1. Companies make disclosure in their annual financial reports about meeting D&I targets on a ‘comply or explain’ basis.
  2. That at least 40% of boards are women; at least one senior board member should be female, and one member of the board should be from a non-white background.
  3. Standardised data on the composition of the board and most senior executives by gender and ethnicity.
  4. Amended disclosure guidance and transparency rules (DTR’s)

Additionally, firms will have to navigate the lines in the sand on conduct, integration and ESG principles as laid out in the Financial Reporting Council's Stewardship Code.

Firms need to think about the outcome expected of disclosure, what the outcome is going to be, and even what will it need to be in the future, says Katerina Joannou, Manager, Capital Markets Policy, Corporate Finance Faculty, ICAEW.

Firms should to buy into the system the regulation is trying to create, and create aspirational targets, like 30% of all board members being women, as suggested by the Hampton-Alexander Review, she adds.

The legislation should capture the behavioural aspect of diversity and inclusion for firms. This is the spirit of the regulation, rather than the words, and should go beyond ticking boxes. The regulation should push firms to listen to under-represented voices within organisations.

'The regulation is not a silver bullet for best practice, but it’s something that can get companies to start thinking about thinking about what they are doing and why,” says Joannou.

“Disclosure for the sake of it is not going to get businesses to wholeheartedly support it.”

One of the key points from the ICAEW’s response to the consultation is that the regulation should highlight the need for consistency of any required data. This makes it a fixed commitment.

“Systems being used should have consistency, either across the regulation or from year to year,” adds Joannou.

“Any standard needs to avoid the massaging of numbers, or include in the reporting the basis of calculating from year to year.”

Financial services

As well as the FCA consultation for listed companies, there is also a wider discussion paper in play concerning diversity and inclusion in financial services, to which ICAEW has responded, and the BVCA.

A wide response, it has three key points for regulators to consider.

Inclusion is the real goal for regulators – as Joannou and Manku both described, diversity alone risks becoming a quota to be filled rather than a reality.

The second issue is data; its consistency and regularity is key.

And the third issue that the ICAEW and others see for successful integration of diversity and inclusion is persuading behavioural change from “incumbents and detractors”.

Many with hard-won financial services careers, and a set view point on how they earned them, may put blockers out for full integration of inclusion as part of a competitive environment.

Maybe the change will come from the top, as per investor pressure, and fundamentally money talks. says Joannou.

“Private company’s mandates are changing, and we have seen some of the larger investors say they won’t invest in them, like Larry Fink, who said they won’t invest in businesses who don’t meet diversity standards.”

Remuneration influence

The regulators (the FCA, PRA and Bank of England) write in their current discussion paper that remuneration is slowly becoming linked to diversity and inclusion for senior management.

“The 2021 annual review of the Women in Finance Charter signatories finds that firms are increasingly linking D&I to the personal objectives of senior management (through remuneration scorecards for example), and through a collective objective for the firm or business unit. Only 5% of signatories have reported that they believe the link to remuneration not to be effective,” it wrote.

Linking progress on diversity and inclusion to remuneration could be a key tool for driving accountability in firms and incentivise progress, said the FCA.

“All PRA and FCA remuneration policies include a requirement for firms to base variable remuneration awards on financial and nonfinancial performance for their Material Risk Taker population (individuals who can materially affect the risk profile of the firm).”

Part of this can help integrate inclusion now.

The BVCA’s Manku sees remuneration already linked to gender equalisation in firms.

“The financial services firms that have signed up to HMT’s Women in Finance Charter already have this link to remuneration as part of their requirements,” she says.

“There are firms who are already adjusting their approach in advance of the regulation.”

How to change pay

As for how, often ESG incentives have been linked to bonuses, but a paper from the Harvard Business School on corporate governance has suggested boards create novel remuneration systems for ESG requirements.

It suggests two separate plans, one matching what companies have now and that emphasises shareholder value, and the other focusing on financial metrics, with annual and long term programs.

The second plan would emphasize ESG factors and signal commitment from the whole organisation commitment, even if the plan’s dollar value was less than the shareholder plan’s value.

“The second plan would tackle long-term sustainability and creating value for major stakeholders,” says the paper.

“By focusing on ESG metrics that satisfy the requirements outlined above, it would also serve investors in the long run. It would generate awards only from clear stakeholder improvements, with downward adjustment if other stakeholders suffered material harm.”

The paper goes on to say that boards could still have overriding authority as appropriate, with share based awards subjecting the payment to variable accounting. Third parties could have oversight to maintain credibility, suggests the paper.

The science behind the thinking

Deloitte research has examined some of the psycho-social influences behind how we group together and think, which is essentially the key to inclusion becoming a success.

They ask us to consider how humans bond and choose friends. Noting that, people choose friends who are much like themselves in a wide array of characteristics. Of a similar age, race, religion, socioeconomic status, educational level, political leaning, pulchritude rating, even handgrip strength.

Scientists have found that friends’ brains react similarly to stimuli, and the tendency to associate with similar individuals, homophily, is counter to inclusion.

The state of play

Whether it is through gradual progress, or causal shock, diversity and inclusion reform is already here.

#Metoo, BlackLivesMatter and other social justice movements have required the world to shift its awareness.

It will perhaps be a mixture of influence from the regulators, and assimilation that works

As an example, the competition between Tech firms and financial services got the ball rolling with working conditions and expectations on remuneration in the 00's.

Facebook, Google and Amazon started pulling talent away from financial services as they could compete on salaries, offer freer working patterns, better perks and a nascent working culture.

They in turn influenced financial services through competition for talent.

The next iteration in the generational shift of market competition will see firms that make equality, diversity and inclusion an integral part of their culture, while still maintaining meritocracy on performance, attract the best recruits.