Common ownership among the ‘Big Three’ of BlackRock, Vanguard and State Street Global Advisors (SSGA) has been a concern for a number of years and while steps are being taken to address the issue, it remains one of the biggest challenges for the ETF and wider indexing industry.
Passive power is a concern that has genuine merit. Due to the explosion of index funds and ETFs over the past decade – especially in the US – the 'Big Three' hold significant control over every major company in the US, and this looks only set to increase as assets continue to pour in over the next decade.
This is the stark warning issued at the end of Robin Wigglesworth’s book, Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever, which warned the bigger will simply get bigger and this could leave major issues from a corporate governance perspective.
Speaking to ETF Stream, Wigglesworth said: “The scale nature of the index industry means the big will naturally get bigger and barring any unforeseen regulatory intervention, BlackRock and Vanguard are going to become even more titanic than they are today.
“At some point, they will control the majority of votes of every major company in the US and globally. This will be one of the defining battlegrounds for index funds and ETFs in the coming decade given the trend shaping the market today.”
His views are supported by Harvard Law School’s Lucian Bebchuk and Boston University’s Scott Hirst, who, in a 2019 paper, titled Index Funds and the Future of Corporate Governance, predicted the ‘Big Three’ could account for 33% of shareholder votes within the next decade, up from 5% in 1998 and around 20% today.
Meanwhile, Harvard Law School’s John Coates, in a paper titled The Problem of Twelve, said: “The agents of index fund providers pose one of the biggest new challenges for the future of corporate governance. Unless the law changes, the effect of indexation will be to turn the concept of ‘passive’ investing on its head and produce the greatest concentration of economic control in our lifetimes.”
Recognising this potential issue further down the line, BlackRock has taken an active step in allaying concerns by offering asset owners in 40% of its $4.8trn equity index funds the opportunity to vote directly with companies, instead of the firm partaking itself.
While this goes some way in addressing the issue in wider indexing, the problem will continue in the ETF space where there is less transparency on who owns the ETFs due to the fact they trade on the secondary market.
Unless there is transparency on who the asset owners are, BlackRock or any other ETF issuer will be unable to pass on corporate governance responsibilities to investors.
“BlackRock and others recognise concerns about this. They do not want to imperil their business by overreaching too much,” Wigglesworth stressed.
There is the option for ETF issuers to loan out their votes to a third party or, as Wigglesworth suggested, remove passives from voting altogether, however, this seems an extreme option given the current sharp focus on engagement.
If transparency issues are not addressed, the ‘Big Three’ will have to find a solution for ETFs specifically as their dominance increases or risk incoming regulation in the future.