BlackRock’s decision to offer institutional investors the chance to vote directly with companies has been hailed by many as a great step forward for engagement, but the reality might be a little more muted, according to an article in the Harvard Law School Forum on Corporate Governance.
The initial announcement from BlackRock came in early October, with the firm stating those invested in some 40% of its $4.8trn equity index assets would be able to vote at shareholder meetings, effective 1 January 2022.
In a letter to clients, BlackRock said: “This capability...responds to a growing interest in investment stewardship from our clients. These options are designed to enable you to have a greater say in proxy voting.”
Demand for voting rights has been particularly strong among clients invested in passive products incorporating ESG and climate metrics, with many concerned about asset managers’ tendencies to vote largely in line with companies’ management.
The decision to offer voting rights also addresses an argument increasingly levelled against passive investment: that the ‘Big Three’ – BlackRock, Vanguard and State Street – account for 80% of the US ETF market and in turn have an overly large say in the decisions shaping the US economy.
Sceptical of the degree of impact the measures will have, Douglas Chia, founder and president of Soundboard Governance LLC, wrote a piece for Harvard’s corporate governance forum titled BlackRock’s Move to Expand Proxy Voting Choice Creates Unknowns.
In it, Chia argued BlackRock’s decision to expand proxy voting rights makes it appear a good corporate governance actor by furthering shareholder democracy but also means it can deflect criticism it normally receives for not using its large voting power in more activist ways.
Chia concluded the move may not end up having much of an impact on proxy voting outcomes, given many clients will likely take the option of continuing to defer to BlackRock’s discretion during voting processes.
“Similar to not having to actively manage investments in individual portfolio companies, part of the attraction of investing in index funds is leaving the decisions and mechanics on hundreds of proxy votes to the asset manager, all at very low cost,” Chia noted.
“While the largest asset owners have dedicated personnel to analyse and make voting decisions at individual companies, the rest cannot incur that cost. BlackRock may be giving its clients options that most will not use.”
Risks in uncharted territory
He added the move from the world’s largest ETF issuer also comes with a few unknowns surrounding voting disclosure and securities lending.
On the former, BlackRock will offer its clients several options on how to manage their voting rights, including leaving BlackRock with full discretion. The issue, Chia said, is onlookers will not know which of BlackRock’s clients choose to exercise their voting rights. Even when the firm submits its Form N-PX filings, information on whether clients have used their new proxy voting powers will be public unless BlackRock or its clients voluntarily disclose it.
He continued, saying unlike asset managers, asset owners are not obliged to report their proxy votes in any SEC filing. While some large owners like CalPERS and NYCERS disclose their votes on their websites, this is not commonplace.
Although the SEC recently proposed rules requiring asset owners to file Form N-PX notes, Chia warned these will only require owners to disclose on “say on pay” votes and not those on company director elections, shareholder proposals and other proxy items.
BlackRock will also be unlikely to surrender such information to stakeholders without the express consent of its clients, which is far-fetched given investors’ proclivity for privacy.
Chia said: “This means many of BlackRock’s institutional indexed clients will be able to conceal a large portion of the votes they decide on for themselves, thus making it more difficult for companies and their proxy solicitors to accurately predict how large blocks of shares held by BlackRock will be voted.”
Another area of uncertainty is how the new proxy voting rights will impact BlackRock’s securities lending business, which pulled in $652m in revenue last year – and 4.2% of its Generally Accepted Accounting Principles (GAAP) revenue between 2018 and 2020.
When securities lending occurs, BlackRock hands over shares to a borrower and temporarily surrenders its rights to proxy voting, dividends and other distributions until the loan is terminated. Of course, asset managers are allowed to recall lent-out shares in order to exercise voting rights but do so with the possibility of losing revenue it would have earned from its lending activity.
BlackRock giving its clients the power to instruct it on how to vote could mean having to recall a larger portion of lent shares than it has in recent years, especially if some voting matters BlackRock views as immaterial are viewed as more important by some its larger institutional investors.
At least initially, BlackRock could lose out on share lending activity as borrowers might opt to use lenders less likely to recall the shares they borrow. However, if other firms follow in BlackRock’s footsteps and decide to implement client-instructed voting, Chia said there may be situations where hedge funds struggle to locate shares of certain companies, making it harder for them to sell short or vote when most desirable.
The definite upshot of this, of course, is if all firms decide to democratise their voting practices, this will put more control directly in the hands of investors. This would not only allay some concerns about the perceived threat of index fund providers’ increasing power but would hopefully mean the largest institutional investors would be more able to directly express their own clients’ preferences on areas such as ESG.