Vanguard scores quick non-aggression pact with FDIC by surrendering proxy powers but analyst asks: 'Why die on that bridge?'
The Malvern, Pa. fund giant eased fears it might be forced to reduce its bank holdings, which would jeopardize the accuracy of its index fund tracking, but not before signing away much of its power to influence U.S. banks -- and accepting massive ongoing regulatory scrutiny.
7 min read
Brooke's Note: We all know that Vanguard is such a renegade company the SEC can't control it. We need to bring in more federal regulators to curb its excesses, said almost nobody… ever. But here we have it. Vanguard was pretty much bullied into accepting a sweeping pact with the FDIC to open its books, subject itself to audits, and never express an opinion directly or by proxy about any U.S. bank. It was those liberals that wrapped Vanguard in another layer of red tape, right? No, conservatives did it. They may hate red tape, in theory, but hate even more that Vanguard – using its free-market powers – might weigh in on carbon emissions through proxy power. So 2024 will end on this ironic news – fitting perhaps for a topsy-turvy year.
Vanguard Group will enter 2025 with a big monkey off its back – but at the expense of giving federal regulators the power to look over its shoulder, shout instructions from the back seat, and curb what it deems excesses.
The Malvern, Pa., fund giant just signed a mutual non-aggression pact with the Federal Deposit Insurance Corp. (FDIC), removing an existential threat to its funds' ability to accurately track markets. See: FDIC bid to strip BlackRock and Vanguard of superpower 'has legs' and reckoning may start with curbs on self-certification of passive index funds
“Today’s agreement with Vanguard is a good step in the right direction,” said FDIC board member Jonathan McKernan, in a Dec. 27 statement.
“It adds specificity as to what it means to be a passive investor in FDIC-supervised banks or their holding companies,” he adds.
“More importantly, it also enhances the FDIC’s ability to monitor and confirm that passivity,” he concludes.
Neither Vanguard nor BlackRock responded to a Sunday query for comment.
Closer scrutiny
The FDIC previously stated it was considering tighter regulations to curb the proxy voting power of passive fund managers, Vanguard included, and perhaps even banning more than 10% ownership of any domestic banking stock.
Under the new deal, the U.S. bank supervisor and insurer will not limit Vanguard's ability to buy large volumes of banking stock, ending the threat to its indexes that analysts say it leveled just before an April FDIC meeting.
More broadly, it will accept Vanguard's passive status, but at a price. Vanguard must promise not to exert its massive proxy powers over the banks the regulator oversees and accept FDIC scrutiny to ensure it keeps up its end of the bargain. See: How ESG put Vanguard and BlackRock on ‘passive’ countdown.
Suddenly Vanguard, BlackRock, State Street not only have the assets but the power of ESG mandates, which make them a growing threat to shareholder democracy, critics say
A silent victory
The deal is a win for Vanguard, too, because it's giving away powers it never exerted in the first place, says Jeff DeMaso, publisher and editor of the Independent Vanguard Adviser, in an email exchange.
“Vanguard's been looking to more clearly define what it means to be a ‘passive’ investor with the regulators,” he says.
It “wants to ‘know’ that if it follows certain rules, then it won't lose its passive exemptions and status. Vanguard doesn't like uncertainty.
“This passivity agreement achieves that without Vanguard having to give up much. They were never in the activity game of shaking up boards," he adds.
Former banking consultant Jonathan Holtoway counters that Vanguard likely capitulated too far and too fast to political pressure.
“I [first] had the thought that they caved too quickly, particularly with a new administration around the corner,” says Holtoway, now president and manager of Ategra Capital Management, a private equity firm, and asset manager in Vienna, Va., in an email exchange.
"My second thought was that the banking sector has become very tiny compared to the capitalization of the rest of the market, so why die on that bridge?"
Quick work
Story Timeline
The regulator first handed Vanguard – and BlackRock – its terms Oct. 4, giving them a three-week turnaround to agree, according to a Semafor report.
The two firms were given a reprieve until Dec. 31, American Banker reported.
Now, having agreed terms, Vanguard can no longer “direct or attempt to direct the management or policies of a [bank] or any of its subsidiaries," the agreement states.
Vanguard cites shunned founder Jack Bogle to deflect criticism after epic ESG flip-flop, extoling the founder's 'whole haystack' investing strategy versus finding the 'needle'
Indeed, it can't even propose a board member, or in any way try to 'influence' a bank's behavior.
Loophole scrutiny
McKernan also clinched the right to introduce further limitations or greater oversight on Vanguard, should the fund manager exploit a potential loophole in the agreement, namely, “informal engagements" with "management of FDIC-supervised banks."
“Going forward, it will be up to the FDIC to implement a plan to monitor Vanguard’s investment stewardship activities,” he writes.
“It will be critically important that the FDIC periodically assess how Vanguard’s front-line business units, independent risk function, and internal audit function monitor, test, and audit its compliance with its related policies and procedures," he says.
"In particular, the FDIC will need to keep a close eye on any informal engagements Vanguard might have … To that end, the FDIC should scrutinize Vanguard’s own compliance program," he adds.
'Body of evidence’
Vanguard has no history of pushing banks or their boards to achieve or further its own agenda. But it spooked regulatory board members and industry observers when it banded together with BlackRock and other fund managers on ESG issues. See: Vanguard, BlackRock, State Street not only have the assets but the power of ESG mandates.
Indeed, its decision sparked particular alarm when it joined the Net Zero Asset Managers (NZAM) group – an ESG ‘alliance’ focused on reducing carbon emissions – with a vast swath of the asset management industry.
“The Big Three [BlackRock, Vanguard, and State Street] purport to be merely passive investors, but a growing body of evidence suggests that’s not always the case,” said McKernan in January, alluding to NZAM.
“Some critics have pointed to evidence that these index fund complexes have pushed ESG agendas at public companies,” he said in his latest statement on the subject.
“Others have expressed concerns about the risks to competition posed by concentrated ownership, [and] still others have focused more generally on the concentration of power in a few institutional investors,” he added.
Net zeroes?
Vanguard quickly withdrew from NZAM, allegedly after politically conservative institutional clients rebelled. Vanguard cites shunned founder Jack Bogle to deflect criticism after epic ESG flip-flop.
Its departure, however, irked climate campaigners. See: Vanguard Group faces backlash for 'taking orders' from climate skeptics and spurning ESG activists, who are calling firm to account with PR campaign.
NZAM remains a going concern with 325 members, which manage or administer a combined $57.5 trillion, although it has suffered from several high-profile departures.
JPMorgan Chase and State Street notably left the 'alliance,' earlier this year. Goldman Sachs followed suit in December.
Vanguard will start the new year with two new top executives, who will begin working together for the first time under the new FDIC pact. See: Vanguard completes shakeup with outsiders Salim Ramji, Joanna Rotenberg supplanting firm lifers Tim Buckley, Karin Risi as RIA takes center stage
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