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Background

In January, I raised some questions about the role played by the “Big Three” asset managers in our banking system.1

I noted that, thanks to the popularity of their index funds, these asset managers have accumulated significant equity investments in the holding companies of many �౦��Ϸ����-supervised banks.2

I noted those investments come with significant voting power, and I asked whether that voting power, together with the investment stewardship activities of these asset managers, might raise a question as to whether any of these asset managers “controls” an �౦��Ϸ����-supervised bank for purposes of the banking laws enforced by the �౦��Ϸ����. If there were control, that would of course trigger a host of regulatory requirements and restrictions.3

I also suggested that we at the �౦��Ϸ���� should revisit how we monitor this issue, in particular to confirm that these purportedly passive investors are actually indeed passive. 

One asset manager has agreed to abide by certain passivity commitments as a condition to regulatory comfort that the �౦��Ϸ���� provided as to how much it can own, and what activities it may engage in, without being found to “control” an �౦��Ϸ����-supervised bank for purposes of the Change in Bank Control Act. Notably, however, the �౦��Ϸ���� has not done much to monitor compliance with those passivity commitments. The �౦��Ϸ���� essentially relies only on the asset manager’s annual self-certifications of compliance.

More generally, the �౦��Ϸ���� also has not done much to otherwise periodically assess whether any of the passive index fund managers “controls” an �౦��Ϸ����-supervised bank. 

And so I’ve suggested that we should probably be doing more.

My Monitoring Proposal

To that end, I have developed a proposal to enhance the �౦��Ϸ����’s monitoring of this issue.

Under my proposal, the Board would direct staff to assess each year whether certain asset managers that manage large index funds control an �౦��Ϸ����-supervised bank.

To the extent an asset manager relies on a passivity commitment or other similar regulatory comfort to avoid a control determination, staff would also assess each year whether that asset manager complied with any commitments or other conditions under that comfort. 

That’s it. It’s that simple. Very basic. All I’m trying to do is get us to monitor compliance with existing law.

This is cautious incrementalism in action. Exceedingly so.

The proposal doesn’t require a change in law. It requires only that we enforce existing law.

The proposal doesn’t apply to actively managed funds. It applies only to two or maybe three passive index fund complexes.

The proposal doesn’t even contemplate changes to the existing well-settled passivity framework. 

Again, this proposal is just about monitoring for compliance with existing law.

And so it’s a bit of a head-scratcher to me that this might not get a unanimous vote today. 

It seems to me that we should all be able to lock arms so that we can say after this meeting “the age of self-certifications” has come to an end.

But my sense is that’s not how the votes are going to land.

So what’s going on here?

The Case Against

I suspect some of my fellow directors might suggest that this should be a staff-driven exercise, that we shouldn’t need Board action to get to this result.

Well, I agree. Ideally this would be a staff-driven effort.

In fact, in the lead up to today’s vote, there was indeed quite a bit of back and forth internally about staff sending certain of these asset managers some letters that would have provided something to the effect that after some date certain in the future we would expect, consistent with existing law, that either they file a notice under the Change in Bank Control Act with respect to each of their large direct and indirect investments in an �౦��Ϸ����-supervised bank or, alternatively, rebut the presumption of control.

Had we sent those letters, we wouldn’t need a vote on my proposal today.

That’s because filing a notice for every investment is not practicable for index fund managers. 

And so that would have left them needing to rebut the presumption of control, with probably the only practicable approach there being a blanket passivity commitment with the �౦��Ϸ����.

We could, had we wanted, then included monitoring provisions in that passivity commitment.

Again, all we needed to do today to avoid a vote on my proposal was to send these letters to these fund complexes.

But for reasons that remain unclear to me, that was somehow going too far.

That’s unfortunate indeed. I just don’t understand why we’re reluctant to take even small steps to enforce our own laws. Without enforcement, the law doesn’t mean much.

So here we are, stuck with this effort at Board action to drive agency action.

Conclusion

Pulling this to a close, we’ve a couple asset managers that insist their index funds are passive. 

If that is truly so, there might not be much issue under the banking laws. 

But to the extent these asset managers leverage their purportedly passive index funds to influence bank policy, then there is a real and significant problem here, and it’s one that the �౦��Ϸ���� needs to get in front of quickly before the influence of these fund complexes grows even larger.

• 1

  See Remarks by Jonathan McKernan, Director, �౦��Ϸ���� Board of Directors, at the Session on Financial Regulation at the Annual Meeting of the Association of American Law Schools (Jan. 5, 2024). For a survey of the academic literature related to this question, and examples of the Big Three’s influence over corporate policy, see generally (Dec. 2022)

• 2

  Lucian A. Bebchuk & Scott Hirst, Big Three Power, and Why It Matters, 102 B.U. L. Rev. 1547, 1552 (2022) (“[W]e estimate that, as of the end of 2021, the Big Three [Vanguard, BlackRock, and State Street] collectively held a median stake of 21.9% in S&P 500 companies, which represented a proportion of 24.9% of the votes cast at the annual meetings of those companies.”); Lucian A. Bebchuk & Scott Hirst, The Specter of the Giant Three, 99 B.U. L. Rev. 721, 736 (2019) (“[T]he average share of the votes cast at S&P 500 companies at the end of 2017 was 8.7% for BlackRock, 11.1% for Vanguard, and 5.6% for [State Street] . . . . As a result, for S&P 500 companies, the proportion of the total votes that were cast by the Big Three was about 25.4% on average . . . .”).

• 3

  If a company acquires direct or indirect control of a bank, that change in control generally is subject to regulatory review under the Bank Holding Company Act or the Change in Bank Control Act. If a company directly or indirectly controls a bank, that company typically is a bank holding company subject under the Bank Holding Company Act to (i) restrictions on its commercial activities, (ii) capital and liquidity requirements, and (iii) an obligation to serve as a source of strength to the controlled bank, among other things. If a company acquires more than 10 percent of a class of a bank’s voting securities, the bank generally is subject to restrictions on extensions of credit to the company and the company’s controlled affiliates under the Federal Reserve Board’s Regulation O. The triggers for control under these laws do vary to some extent.