As the ETF industry grows, concern about the market effects likewise increases. Though market stability and liquidity are typical concerns, one firm’s recent letter to clients highlighted the potential problem of ETF-based activism in corporate boardrooms.
In his Q2 partnership letter, Talbot Babineau, president and CEO of IBV Capital, discussed the consolidation of proxy voting power to a select few ETF providers.
Referring to the increasing growth of ETFs’ investment in public companies, he said in the letter: “Since most ETF providers do not transfer proxy voting authority to their ETF investors, this growth has placed ETF providers in the unprecedented position of being the 800-pound gorilla in boardrooms around the world.”
BlackRock is an example. In an annual letter posted earlier this year, BlackRock CEO Larry Fink said the firm’s practice has transformed from focusing on proxy voting to company engagement.
“To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society,” Fink said in the letter, addressed to CEOs. “Companies must benefit all of their stakeholders, including shareholders, employees, customers and the communities in which they operate.”
Subsequently, in a March release, BlackRock said it would engage with gun companies about their policies and practices. (The focus was on companies held in BlackRock index funds, the stocks of which are chosen by third parties, not by BlackRock managers. In its active equity portfolios, BlackRock holds no gun manufacturers, the release said.)
With its focus on engagement, BlackRock put itself in an awkward position with companies that might be motivated to consider socially responsible actions, as noted in a Bloomberg commentary. It also raised questions about the appropriateness of engagement.
For example, since gun companies already work within a legislative framework, “it’s fair to presume BlackRock’s engagement is to [e]ffect some form of change,” says Babineau in his letter. That makes BlackRock’s announcement “a watershed moment in the passive investment space.”
And, leaving aside the charged topic of guns, he notes the potential problem of engagement when an ETF provider holds social views that differ from those of investors.
A potential conflict also arises, he adds, since the voting influence of a firm’s passively managed products could be used to achieve certain objectives in that firm’s active portfolios.
On its website, BlackRock says it votes globally at more than 15,000 shareholder meetings annually, on more than 130,000 proposals. While its starting point is to support management, the firm says it votes against management proposals if the company is unresponsive or is acting contrary to shareholders’ interests.
In its proxy voting guidelines for U.S. securities, BlackRock says it expects companies to identify and report on material, business-specific environmental and social risks and explain how these are managed.
When explaining its intent to use proxy voting power to influence corporate governance, the firm appeals to clients’ financial benefit. “We do not see it as our role to make social, ethical or political judgments on behalf of clients, but rather to protect their long-term economic interests as shareholders,” the proxy voting guidelines say.
Babineau says he’s disappointed that the consequences of voting power consolidation haven’t yet been meaningfully debated.
An ETF report from EY notes that there’s growing regulatory focus on the systemic risks associated with ETFs, and that the likelihood of ETF-specific regulation is increasing as the ETF industry expands. However, regulatory focus is mostly expected to affect distribution incentives.
In the meantime, “We will continue to be acutely aware of the impact passive investment products have on corporate governance matters,” says Babineau, “and consider this factor in our investment process.”
For full details, read IBV Capital’s Q2 partnership letter.