Listed financial firms in the UK have been warned by regulator the Financial Conduct Authority that the first annual reports to cover new diversity and inclusion (D&I) reporting requirements must hit D&I targets or contain "clear and meaningful explanation' of why targets were missed.

In a briefing note on 24 March, international law firm Pinsent Masons said new targets were introduced last year and in April the first annual reports to take account of new obligations will be published.

The rules require that 40% of the board are women, that at least one board member is from a minority ethnic background, and that a woman holds at least one of the firm's most senior positions: chair; chief executive; chief financial officer or senior independent director.

The FCA has published a reminder of its expectations of companies when they have failed to meet targets. "There are requirements…to set out the targets not met and provide the ‘reasons' for not doing so. Companies should provide clear and meaningful explanations as to why they have not met targets," it said.

"The FCA wants D&I embedded into corporate governance to promote D&I, increase stakeholder transparency and inform investment decisions which increasingly see D&I as relevant to company valuations," said employment expert Anne Sammon of Pinsent Masons.

"The FCA will be watching first year reporting to ensure there is more than a tick-box approach to complying with the new disclosure rules. Light touch compliance to new reporting obligations is a natural trap to fall into and the Financial Reporting Council said that this happened when new rules on reporting on employee engagement were introduced in 2019.

"This can mean that opportunities to engage in a reporting process that feeds into real change are missed. To maximise the new rules' potential to have a meaningful impact, it is no surprise that emphasis is placed by the FCA on narrative and data collection."

The rules require that companies listed on the stock exchange report numerical data on the ethnic background and the gender identity or sex of the individuals on the listed company's board and in its executive management.

Corporate governance statements must contain descriptions of a company's diversity policy in relation to ethnicity, sexual orientation, disability and socio-economic backgrounds. Requirements already exist in relation to age, gender and educational backgrounds.

Companies can include in their annual reports summaries of policies, procedures or processes that they think improve the diversity of the firm. They can also outline mitigating factors and risks in relation to the targets.

The rules require clarity, said Sammon. "Narratives around D&I at board level need to be clear and meaningful. Paying lip service to target failures or data gaps will not be sufficient. They need to be explained. Best practice is also likely to go beyond explaining failures and focus on remedial planning," she said.

"There is also a watchful eye on social washing which, similar to greenwashing, is the making of false or misleading claims around social risks and impact. Social washing may be accidental and result from a desire to develop an inclusive reputation and be welcoming. However, employers are likely to become increasingly sensitive to the legal, regulatory and reputational risks around accusations of social washing."

Sammon said that some data may not be reportable because of legal restrictions on data collection, but that even those gaps must be explained.

"Employers reporting under the new rules in 2023 should take-away from this bulletin that lawful data collection comes first. Second comes contextualising that data within a meaningful and honest narrative which reflects a forward thinking D&I strategy," she said.

Corporate law expert James Kaye of Pinsent Masons said that D&I reporting was being extended beyond just listed companies: "The direction of travel on D&I reporting is towards wider application. Listed companies are already required to report and larger private companies are next but it will not stop there. For example, the Private Equity Reporting Group has expressed its intention to increase diversity disclosure requirements as those for listed companies increase."

Meanwhile the Parker Review, set up by the UK government in 2015 to assess the ethnic diversity of UK company boards, has announced plans to extend targets to smaller companies and those not listed on a stock exchange (6-page / 200KB PDF).

The Review had set targets for companies in the FTSE 100 and FTSE 250 lists of the UK's largest listed companies.

The Review will now extend its target-setting to companies in the FTSE 350 index. It wants them to set a percentage target for minority ethnic representation in senior management positions to be reached by the end of 2027.

It is extending activity to un-listed companies too. It said that 50 of the UK's largest private companies have been set the target of having at least one ethnic minority director on the main board by December 2027. Each company will also be asked to set a target for the percentage of ethnic minority executives within its senior management team.

Its 2022 voluntary census found that 96 of the FTSE 100 companies met the target of having one minority ethnic director on their boards.