Increased focus from investors, regulators, and employees on racial, ethnic and gender diversity has heightened scrutiny of public companies' commitments to diversity in their workforce and in particular on their boards.
What is changing?
In April 2022, the Financial Conduct Authority (FCA) published its Policy Statement on diversity and inclusion for company boards and executive management. The new rules apply to certain listed companies for the financial years starting from 1 April 2022. From this date, the Listing Rules require certain companies with premium or standard listed equity shares or depositary receipts to include in their annual reports:
- a "comply or explain statement " describing whether they have achieved certain specified targets for women and ethnic minority representation on their board1; and
- a standardised numerical disclosure on the ethnic background and gender identity or sex of their board, key board positions and executive management team2.
For companies with a 31 December financial year end, the annual report they publish in 2024 (for the FY 2023 financial period) will be the first time they have to report on the new Listing Rule targets, so companies which have not voluntarily made these disclosures in 2023 will need to ensure they are in a position to make such disclosures in 2024.
What do the Listing Rules say?
Companies subject to the new rules must have (or explain why they do not have):
- a minimum of 40% women on the board;
- at least one of the senior board positions (Chair, CEO, Senior Independent Director or CFO) held by a woman; and
- at least one member of the board from a minority ethnic background (which is defined by reference to categories recommended by the Office for National Statistics (ONS)) excluding those listed, by the ONS, as coming from a White ethnic background.
The scope of the Listing Rule disclosures includes UK and overseas companies with equity shares (basically ordinary shares), or equity shares represented by certificates (including global depositary receipts), admitted to either the premium or standard listing segments of the FCA's Official List in the UK. This includes closed-ended investment funds (e.g. investment trusts) but excludes shell companies (e.g. SPACs).
What does this mean for annual reporting?
Annual reports must include numerical tables which set out in a prescribed format: (i) the sex or gender identity of; and (ii) the ethnicity of, board members, those in senior board positions, and executive management.
Listed companies must also explain their approach to collating diversity data to meet these disclosure requirements, including the method, source, whether this has been collated by self-reporting, and if it has, a description of the questions asked.
Existing rule DTR 7.2.8AR has also been amended to provide that disclosure relating to the board diversity policy should include the diversity policies which apply to its board committees (i.e. the remuneration committee, audit committee and nomination committee) and these policies should have regard to "wider diversity aspects ", such as ethnicity, sexual orientation, disability and socio-economic background.
On a voluntary basis, companies may also include numerical data on the diversity of the members of its board committees. A summary of key policies, procedures, processes and other factors contributing to improving diversity at board and executive level may also be included in the report.
Lastly, companies may include a brief summary of any mitigating factors or circumstances which make achieving diversity on boards more challenging, or any risks they foresee in being able to meet the board diversity targets.
How will the new targets be enforced?
As with other "comply or explain " requirements, failure to meet the FCA's new targets does not constitute a breach of the Listing Rules, provided that the company discloses this fact and its reasons for not meeting the relevant target.
What are the proxy advisors saying?
The investment community continues to take steps to steer companies to follow best-practice guidance. For 2023, IVIS (aligned with the ambition to hit the FTSE Women Leaders Women on Board targets by 2025) have stated that they will red top FTSE 350 companies where women represent:
- 35% or less of the board; or
- 30% or less of the executive committee and their direct reports.
IVIS will also red top FTSE Small Cap companies where women represent:
- 25% or less of the board; or
- 25% or less of the executive committee.
In terms of ethnic diversity, IVIS will red top FTSE 100 companies that have not met the 2017 Parker Review target of one director from a minority ethnic group and will amber top FTSE 250 companies that do not disclose either the ethnic diversity of their board or a credible action plan to achieve the Parker Review targets by 2024. Whilst they are monitoring whether companies are meeting the new Listing Rule requirements, at this stage IVIS are not colour topping on this issue.
Summary of evolution of gender diversity targets
Summary of evolution of ethnic diversity targets
What about the proposed changes to the UK Corporate Governance Code on diversity?
Changes proposed to the UK Corporate Governance Code (the "Code ") in the Financial Reporting Counsel's3 ( "FRC ") May 2023 consultation are, according to the FRC, designed to improve reporting on diversity, particularly in relation to the success of diversity policy initiatives. The FRC notes that, whilst the importance of diversity and inclusion in the composition of the board, executive management and in succession planning, is already highlighted in the Code4, there are also a number of mandatory requirements and voluntary initiatives outside of the Code regarding board diversity and inclusion (as outlined above). These requirements are somewhat fragmented, and rather than adding to an already complex reporting landscape, the FRC explains that the changes proposed are designed to facilitate a more unified approach.
The FRC further notes that their revisions are intended to strengthen the Code and support the FCA's changes to the Listing Rules without introducing additional, duplicative targets or regulations.
The FRC has proposed an amendment to current Principle J (Principle I in the new Code) to include a reference to inclusion, and to give equal weight to all protected and non-protected characteristics, to encourage companies to consider diversity beyond gender and ethnicity:
"Both appointments [to the board] and succession plans should be based on merit and objective criteria. They should promote equal opportunity, and diversity and inclusion of protected characteristics and non-protected characteristics including cognitive and personal strengths. "
This is a move away from a list of diversity characteristics to an approach which aims to capture wider characteristics of diversity. However, there is a view that the deletion of "social " background is a retrograde step and that the references to "protected characteristics " import provisions from English legislation which many not be applicable to all premium listed companies (e.g. international issuers). These comments have been fed back to the FRC as part of the consultation process and companies should continue to monitor any response from the FRC and await the final Code revisions. The FRC currently intends that the revised Code will apply to financial years commencing on or after 1 January 2025.
1 LR 9.8.6R(9) for premium listed issuers and LR 14.3.33R(1) for standard listed issuers. LR18.4.3R(2) extends certain provisions of LR 14.3 (including LR 14.3.33R) to standard listed issuers of depositary receipts.
2 LR 9.8.6R(10) for premium listed issuers and LR 14.3.33R(2) for standard listed issuers.
3 Consultation closed on 13 September 2023
4 Current Principles J and L, and Provisions 17, 19 and 23.
