What Happens When Diversity Approaches Become Diverse? Managing Divergent Approaches To DEI

Embracing diversity means championing difference. But what happens when the differences relate to the approach to diversity itself? And what should governance professionals be thinking about in the context of DEI-issues and corporate reporting

Diversity, equity and inclusion, or DEI (because ESG loves an acronym), have been a mainstay in the governance landscape for a number of years now. In the UK, the current focus is the latest chapter in a long history of campaigns to address issues of inequality in society, from reforms to suffrage in the 19^th and 20^th centuries, through the Equal Pay Act in the 1970s to the requirements for increased transparency to drive behavioural change in more recent years. As a result, there is a considerable body of DEI-related legislation in the UK.

Recently however there has been a shift away from wide-scale support of DEI aims towards a more critical analysis of DEI policies and the outcomes they seek to achieve. While there have been signs of this shift in many jurisdictions, the most marked example is in the US.

While the HR team and others will be dealing with the practicalities and the impact on an organisation's policies, procedures and operations (particularly where the organisation operates in the US), in light of these shifting, and differing, narratives and approaches to DEI elsewhere in the world, how can governance professionals in UK listed companies navigate their DEI reporting obligations under the UK regulatory regime? This question has been, and will continue to be, one of considerable focus for companies in their annual report and accounts (ARA), which for many UK listed companies has been the vehicle through which they have proudly articulated their strong commitment to DEI-related issues, highlighted their DEI achievements, and described their progress towards meeting their stated DEI targets.

Recently there has been a shift away from wide-scale support of DEI aims towards a more critical analysis of DEI policies and the outcomes they seek to achieve."

Isobel Hoyle
Knowledge Lawyer

Where DEI reporting obligations arise in the UK regulatory regime

Given how broad the concept of DEI is, it is not surprising that there is a wide range of, often overlapping, reporting obligations which relate to diversity, inclusion and equity which UK listed companies need to comply with. The requirements in relation to the ARA include:

Role breakdown – Under the Companies Act 2006 (CA2006), listed companies are required to include in their strategic report a breakdown of the number of persons of each sex who are (1) directors; (2) senior managers; and (3) employees, of the company.
Gender and ethnicity diversity targets in the UKLRs – Under the UK Listing Rules (UKLRs), listed companies need to disclose in their ARA whether the composition of their board meets three diversity-related targets and if these targets have not been met, the ARA needs to include an explanation why not. In addition, the UKLRs require prescribed numerical data on the ethnic background and gender identity or sex of board members and members of the executive management to be included in the ARA.
Diversity policies – In the corporate governance statement of the ARA, in accordance with the Disclosure Guidance and Transparency Rules (DTRs), listed companies need to include a description of their board diversity policy. This description should cover how the policy is applied with regard to factors such as ethnicity, sexual orientation, disability or educational, professional and socio-economic backgrounds, the objectives of the policy and how the policy has been implemented. If the company does not have a board diversity policy, then the ARA will need to include an explanation as to why not.

These requirements form the baseline for a UK listed company's DEI-related disclosures, with failure to comply with these requirements potentially leading to legal or regulatory sanction.

Layered on top of these requirements are the voluntary initiatives of bodies such as the FTSE Women Leaders Review (on board gender diversity) and the Parker Review (on board ethnic and cultural diversity). Both review bodies have set voluntary targets and recommendations against which many listed companies make disclosures and benchmark their performance. These are not mandatory, but the FCA has largely aligned the requirements in the UKLRs with the approach taken by these reviews, and performance against the reviews' targets and recommendations will often be taken into account by institutional investors.

In addition to the specific DEI-related reporting requirements, many companies have included considerable detail on DEI matters in their narrative, non-financial reporting. For example, DEI-related policies are often discussed when describing the company's policies in relation to employees, and the outcomes of those policies, for the purposes of the non-financial information statement requirements in the CA2006, and progress towards achieving DEI-related targets are often cited in connection with the requirement to describe key non-financial KPIs.

Diversity under the Governance Code

The Financial Reporting Council (FRC) considered expanding the measures on diversity in the UK Corporate Governance Code (Governance Code) when it consulted on changes to the Governance Code in 2023. However ultimately these proposals were not taken forward and other than continuing to require the disclosure of the gender balance of those in senior management and its direct reports (as was the case under the previous edition of the Governance Code), the Governance Code does not contain any specific targets for DEI matters.

The Governance Code does however highlight the importance of DEI in both board appointments and succession planning, and therefore the need to consider diversity as part of the annual review of board performance. Like the provisions relating to diversity in the UKLRs and DTRs, the Governance Code applies on a comply or explain basis and listed companies will need to report on the Governance Code in their ARA. These disclosures should include a description of the DEI policy and initiatives, their objectives and links to the company's strategy and how they have been implemented and progressed over the financial year (which overlaps with the diversity policy disclosure requirements in the DTRs).

In addition to the requirements for the ARA, there are other DEI-related disclosure requirements imposed on UK listed companies. For example, in relation to pay equality, in-scope UK companies are required to make public each year information on differences between the average pay and bonus received by their male and female employees, under regulations passed under the Equality Act 2010 (GPG Regulations). Entities will fall within the scope of the GPG Regulations if they are employers in Great Britian with at least 250 employees. In addition, in the draft Employment Rights Bill, it is proposed that such employers would need to prepare an action plan of how they will address gender pay gaps.

In addition to these gender pay gap reporting requirements, the UK government has consulted on proposals for mandatory ethnicity and disability pay gap reporting, which were trailed in the Labour party's manifesto for the 2024 General Election and form part of the draft Equality (Race and Disability) Bill included in the July 2024 King's Speech. The proposed reporting framework would be very similar to the regime in place under the GPG Regulations.

When companies operate in numerous countries, it will always be necessary to establish how the legal and regulatory regimes of the relevant jurisdictions interplay. DEI-related obligations are no different in this respect."

Christine Young
Partner

Navigating the changes in the US in the context of corporate reporting obligations

There has been much media attention on the changes in the US and concerns have been raised in many jurisdictions about how companies can comply with their obligations under relevant domestic regimes, without triggering issues in the US where entities have significant US trading divisions or engage with US federal agencies. Indeed, such has been the attention on the US approach, that even where there is no US nexus, some entities have questioned the impact for them and how they should respond.

While the situation is still new and developing, there are practical steps which companies may take when preparing DEI-related disclosures for their ARA to be published under the UK reporting regime in the context of the shift in US approach. Governance professionals involved in the preparation of the ARA, or other public disclosures, of UK listed companies should consider the following, seeking input from appropriate colleagues where necessary:

Analyse the DEI-related disclosures

Analyse the DEI-related disclosures proposed for inclusion in the ARA and determine whether each disclosure is being made to comply with a legal or regulatory requirement imposed on the company or whether the disclosure is being made on a voluntary basis or goes beyond the requirements of the relevant reporting regime. Those disclosures which are required in order to comply with obligations to which the company is subject should be included, whereas those disclosures which are voluntary or additional should be subject to further scrutiny.

Consider the expectations of shareholders

Consider the expectations of shareholders and other interested stakeholders in relation to these voluntary or additional disclosures. Is the information decision-useful information which shareholders need? Is it necessary to disclose the information in order to provide a more complete picture of the company's performance or strategy? Is the information being disclosed for a better understanding of, or to contextualise, other information disclosed? These are all valid reasons to include voluntary or additional disclosures, but these reasons may need to be stress-tested against how they may be received more widely.

Be mindful

Be mindful of how disclosures are framed and the language used. Companies should be clear where the information being disclosed is mandatory, rather than being included on a voluntary basis, so that readers of the ARA understand the context in which the information is included. Companies should also be mindful of the language used and ensure that it accurately reflects the scope of the required disclosure. For instance, the UKLRs (unlike the equivalent EU requirements) do not impose mandatory quotas for the number of women listed companies should have on their boards, but rather the rules set aspirational targets. The distinction is meaningful from an employment law perspective to avoid positive discrimination allegations.

Be clear on the scope

Be clear on the scope and extent of policies, processes and initiatives being disclosed. Companies invest significantly in their workforce and will quite rightly want to highlight the employee-friendly initiatives that they have in place which are relevant for recruitment and retention. As such, many companies will seek to ensure that the ARA contains a broad picture of the DEI policies and initiatives in place across the organisation to demonstrate the company's commitment to equal opportunities and inclusion for the entire workforce and also to mitigate the risk of accusations of cherry-picking or misleading disclosures or "social-washing". Where the particular initiatives or case studies are included in the ARA to showcase the application of DEI policies in practice, companies should ensure that it is clear from where in their organisation the case study derives. The territorial scope and application of policies and initiatives should also be clarified, in particular if they do not apply in certain jurisdictions. A statement confirming that the company complies with relevant applicable laws in the jurisdictions in which it operates may also be helpful. In particular, organisations should look closely at any global initiatives including targets as that is a potential area of concern where there is a US part of the organisation. It may be more prudent to focus on jurisdiction specific initiatives and related disclosures.

Seek specific advice

Seek specific advice where there are particular concerns or significant activity in the US, especially given that the situation in the US is fluid. Additionally, organisations require tailored advice based on their industry, location, contracts, clients, and numerous other legal and practical factors. For example, companies with federal contracts or grants face special considerations because non-compliance can jeopardise these agreements. There is no universal approach for organisations. Besides being clear on the scope and extent of policies and initiatives being disclosed, other strategies include refining language and programs to expand the definition of diversity beyond protected categories and removing any reference to affirmative action plans or programs.

As illustrated by other articles in this publication (see in particular 'On your marks, get set... go! Preparing for ISSB'), when companies operate in numerous countries, it will always be necessary to establish how the legal and regulatory regimes of the relevant jurisdictions interplay. DEI-related obligations are no different in this respect and navigating the differences between the regimes will require sound governance and reporting structures, and informed leadership.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.