Standing Out

Diversity and inclusion on company boards and executive committees is an extremely important subject.

On 20 October, the Institute submitted its response to the Financial Conduct Authority (FCA)’s consultation on diversity and inclusion on company boards and executive committees.

This is a really important subject and one which seemed to strike a real chord with members – like the BEIS consultation on Restoring trust in audit and corporate governance, about which I wrote last month, our roundtables with members were oversubscribed.

And although we had some robust debate about some specific issues, there was unanimity about the goal; discussion was confined to the roadmap.

We believe that diversity, broadly defined, including experience and viewpoint, makes for better boards and leadership teams. The FCA noted in the consultation document that although there is some evidence of a positive correlation, “the empirical evidence for the impact of diverse workforces and boards on financial performance is inconclusive” but, as I was regularly reminded in my Archaeology studies, “absence of evidence is not evidence of absence” and it seems to us quite simply that achieving a position in which the best possible candidates for board and leadership roles will be drawn from all available and qualified talent is not just common sense but is also the right thing to do.

A different approach

Consequently, nomination committees and boards need to improve their approach to diversity. Although the pace of women being appointed to FTSE 350 boards has increased – up to 40% of new appointments according to Institute research in 2020, there is still a significant difference between the female share of executive directorships (14.2% in the FTSE 100 and 11% in the FTSE 250) compared with non-executive directorships (42.2% in the FTSE 100 and 39.1% in the FTSE 250). This is the real issue; the need to develop and strengthen the pipeline of women and other under-represented groups ready to move into executive directorships. It is our contention that some of solutions that have been proposed, such as increasing the number of seats on boards for under-represented groups do not go far enough to tackle this core issue.

However, diversity of experience and viewpoint is not just about gender. It’s also about ethnicity, sexual orientation, educational background, age and stage of career as well as any number of other factors. Even then, true diversity depends on the personal characteristics of the individual concerned. Diversity of board membership is a means to an end not an end in itself. One of our members gave us an example of a board, lauded at the time for its high standards of governance, that was diverse enough to score very well against the metrics for gender and ethnicity but which suffered from ‘group-think’ because “nearly all the horses were from the same stable.” Managing board diversity is a critical part of the role of the Chair, with the support of the nomination committee and the Company Secretary.

Diversity should be considered from a succession planning perspective. We need people in the earlier stages of their careers and those with diverse characteristics in the executive pipeline as they will provide a broader perspective. Until now, the focus has been exclusively on women and on NEDs when actually a larger problem is the limited diversity of the executive pipeline.

And what do we mean by ‘board-ready candidates’? Whilst boards are being urged to encourage more diversity, there is a problem around what constitutes an individual being board ready. How do you encourage a board to accept readily people who are not what they might traditionally consider as board-ready? For example, experience on a FTSE board should not be seen as mandatory as this acts only to reduce the potential talent pool, but too many organisations – including Government – include board experience as an essential criterion. There may be lessons to be learned from the military selection processes where people are given considerable responsibility at an earlier stage of their career. With the development of age-discrimination legislation and the need for people to work for longer to get to a pension, we should consider whether we are reducing the opportunity for people to become directors at an earlier stage of their careers.

We believe that one part of the solution is a recognition that company secretaries provide a suitably skilled and experienced board-ready pipeline. They have a very privileged and advantageous position from which to observe boards in action and, in many cases, more boardroom experience than many of the directors with whom they work. And as a professional body, we are certainly seeing much greater diversity in the profession than ten or twenty years ago. At the time of writing, 42 FTSE 100 companies have a female company secretary, and we are seeing increasing numbers of women and people from ethnic minorities joining the profession.

Key issues for company secretaries and their boards to consider include:

  • How representative is the board of the business it leads, of its markets and customer base, and of the society or societies in which it operates?
  • Is the challenge that boards simply want people in their own likeness or are recruitment firms just proposing candidates who fit this bill? What are the views of investors? Are they supportive of diversity?

The proposal from the FCA was that there should be a new Listing Rule requirement that most listed companies should report, in a standardised format and on a ‘comply or explain’ basis, whether: “At least 40% of the board are women (including individuals self-identifying as women); at least one of the senior board positions (Chair, CEO, SID or CFO) is held by a woman (including individuals self-identifying as a woman); and at least one member of the board is from a non-White ethnic minority background (as categorised by the Office of National Statistics (ONS))."

Generally, we were content with those proposals, as they are on a comply or explain basis, but emphasised that the targets should be regularly reviewed against the wider socio-economic factors at play and available qualified talent in the United Kingdom. Our one area of concern was the proposal that “At least one of the senior board positions (Chair, CEO, SID or CFO) is held by a woman (including individuals self-identifying as a woman).” The current low level of female executive directors (14.2% in the FTSE 100 and 11% in the FTSE 250 as noted above) suggests that this will be a particularly high bar for companies to achieve and one that may not yet be justified by the quality of candidates. We argued that, were this proposal to be carried forward, the positions concerned should be broadened to include the chairs of the main board committees. There was a suggestion that we should include the company secretary as well but, given that our profession already meets a number of diversity criteria, this might make compliance rather too easy.

Diverse talent

We also expressed some concerns about the prescriptive data reporting proposed by the FCA. The format seemed quite helpful and we were pleased to see the inclusion of “Not specified/prefer not to say” as we have some anecdotal evidence from our members that some directors, particularly those of mixed ethnicity, would be very sensitive to such reporting. However, one query raised by some companies with an international perspective was the terminology used in the tables. Whilst we understand the logic of deriving these from the ONS categories, these are rather Anglo-centric for use by companies with an international workforce and it may be appropriate to allow some flexibility in terms of the categories used. For example, there was a concern about the use of the term ‘British’ in the tables and a feeling that ‘Other Ethnic Group’ suggests some level of hierarchy – that Arabic or middle eastern might be perceived as less important than the specified categories. Similarly, for companies with a significant American workforce, an additional category of ‘Hispanic’ might also be appropriate.

The FCA also asked whether, in the future, it should “consider requiring similar numerical data reporting for the level below the executive management team of in-scope listed companies and/or seek data on representation by sexual orientation.” We took the view that creating a pipeline of diverse talent should be a priority for companies and regulators alike and we see many benefits to the collection of data on ethnicity and sexual orientation by companies – not least in ensuring that diversity policies are truly effective in practice. We therefore believe that the extension of reporting level below the executive management team of in-scope listed companies may – indeed should – be an aspiration over time.

However, against that must be balanced the fact that many companies do not routinely keep ethnicity or sexual orientation data and consequently its collection may be quite onerous, particularly for companies operating in multiple jurisdictions where it is not always legally permissible to gather such data or, indeed, legal or even safe for employees to give it. There are, we understand, more than 70 countries in the world where homosexuality is illegal. Whilst some companies were justifiably proud of the way in which their policies on diversity and inclusion had been received by staff, others have felt it necessary on legal advice to be circumspect in some jurisdictions. Furthermore, some of our members are concerned that the collection of this data might be widely seen as intrusive and unlikely to produce accurate data. Again, the principle of ‘comply or explain’ and the principle that low levels of reporting should not be seen as a cause for criticism are both important here.

The transition

The FCA were proposing implementation of the changes from accounting periods starting on or after 1 January 2022; we argued that this was far too soon. By the time that this consultation has concluded, and the FCA is in a position to make changes to the listing rules, we will be very close to the proposed commencement date – indeed the ‘next steps’ section of the consultation refers to the FCA’s “aim to make final rules and publish a Policy Statement before the end of 2021.” We argued that any new Listing Rule requirement should apply no earlier than to accounting periods starting on or after 1 January 2023, so that reporting will start to appear in annual financial reports published for that year in spring 2024. Of course, companies that are able to disclose this data, on a voluntary basis, before then will undoubtedly do so.

The final point that we made in our response was that of the potential for confusion in the market between the respective roles of the FCA and the Financial Reporting Council (FRC), especially as the latter transitions to its new guise as the Audit, Reporting and Governance Authority (ARGA). This ‘demarcation’ issue should be a key point to be agreed between the FCA and ARGA.

We see a clear distinction between the making of rules – for example the Listing Rules – with which all listed companies must comply and the establishment of ‘comply or explain’ principles which fit better in the UK Corporate Governance Code. In our view, having more than one regulator responsible for setting reporting requirements risks those requirements becoming confusing and, more importantly, less effective than they might be if subject to a single, integrated approach.

We therefore suggest that the FCA limit the Listing Rule requirement to one that companies must report on those issues covered by the UK Corporate Governance Code, with the FRC or ARGA setting those criteria and assessing the quality of explanations. It seems to us that, with these proposals, the FCA is stepping outside its areas of expertise.

Peter Swabey FCG is policy and research director at the Chartered Governance Institute UK & Ireland

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