The Emergence of Pass-Through Voting and Its Implications for Shareholder Stewardship

Pass-through voting is rapidly emerging as an important feature of the investor stewardship ecosystem. Its novelty lies in enabling investors in pooled funds—both institutional and retail—to have more control over how their proportional share of securities is voted, a decision traditionally delegated to asset managers, now available as a standardised service offering.

If adopted widely, pass-through voting could substantially rebalance power in corporate governance, with significant outcomes for the governance of publicly traded companies. Its direct governance impact operates through the empowerment of asset owner voice. Its indirect governance impact may prove equally consequential, operating through enhanced support for voting policies and guidelines that corporate managers are likely to follow to avoid opposition from the providers of these policies.

For asset owners, pass-through voting is a positive development that enables them to better align shareholder voting with their stewardship preferences, especially on matters where they feel that their views diverge from the views of asset managers. But the practice has generated mixed responses from market participants. Some asset managers hold strong views opposing pass-through voting, based on concerns that separating voting from ownership and engagement may weaken investor influence, limit access to companies, and increase uninformed voting. Corporate boards have also expressed concerns about the implications of pass-through voting for investor communications and the quality of shareholder stewardship.

The emergence of pass-through voting thus raises an obvious question about its impact on shareholder stewardship. We address this question in a new study of pass-through voting in the UK institutional market. Pass-through voting has long been considered and practised in the United Kingdom, with some UK asset managers offering it to select institutional clients, albeit without much publicity. This makes UK practices an excellent lens through which to examine the implications of the growing importance of pass-through voting.

We first develop a theoretical framework for analysing the implications of pass-through voting for shareholder stewardship. We show that pass-through voting presents a three-way trade-off between strengthening the representation of asset owner preferences in stewardship, the integration of information in stewardship decisions, and the consolidation of the mechanisms of investor influence. Accordingly, pass-through voting has nuanced consequences that are context-specific and depend on several factors: the role of stewardship in an asset manager’s investment proposition; the importance of links between stewardship and investment decisions; the degree of misalignment between asset owner preferences and asset manager voting decisions; and access to, and the importance of, firm-specific information or expertise in relation to specific voting agenda items or companies.

Next, we rely on qualitative interviews with key UK institutional market participants to explore the motivations of different actors in order to test and refine the proposed theoretical framework. With the assistance of the Investor & Issuer Forum, an organisation that facilitates dialogue between institutional investors and issuers in the UK, we interviewed executives from 33 organisations—asset owners, asset managers, companies, service providers that facilitate pass-through voting, and regulators. The evidence from the interviews adds detail to the conceptual framework and helps draw out the implications of pass-through voting for shareholder stewardship.

We identify four ways in which pass-through voting may negatively affect the quality of shareholder stewardship:

1)        Disconnecting voting from other stewardship mechanisms through pass-through voting can weaken shareholder stewardship in general and engagement in particular. The degree of this effect largely depends on the investment model. Pass-through voting fits better with the investment model of index funds than with that of active funds, as active managers often rely heavily on the interconnections between voting, engagement, and investment decision-making, and need strong relationships with, and access to, companies in their portfolio.

2)        Pass-through voting may have negative implications for informed shareholder voting if fragmented investors in pooled funds are less likely to be informed voters. This concern is mitigated where the practice is adopted by asset owners with dedicated stewardship resources and is applied selectively in relation to specific issuers or votes.

3)        Pass-through voting is likely to reduce independent shareholder voting and increase the reliance on proxy voting advisors. This effect is particularly strong where pass-through voting is implemented through a menu of policies. Even if due care is given to the choice of a policy, the actual implementation of the policy is left to the proxy adviser, with limited practical fiduciary oversight.

4)        Pass-through voting, if it becomes widespread, is likely to have an adverse impact on the market for stewardship by weakening the incentives for asset managers to adapt their overall stewardship approach to asset owner preferences.

Overall, pass-through voting has nuanced implications for shareholder stewardship. While it creates risks for stewardship, it can also be beneficial under three conditions: when asset managers have a client base with strongly divergent preferences on stewardship topics; when stewardship, including the integration of voting and engagement, is not central to the asset manager’s investment proposition, leading to low costs of separating voting from engagement; and when the practice is adopted by asset owners selectively and responsibly, with appropriate oversight.

Under these conditions, pass-through voting may be a pragmatic second-best solution, particularly for asset owners that are unable to switch managers easily or to achieve alignment through mandate selection.

The full article is forthcoming in the Journal of Corporation Law and can be found here.

Suren Gomtsian is an Assistant Professor of Law and Tom Gosling is Professor in Practice and Director of the Initiative in Sustainable Finance, Financial Markets Group at the London School of Economics and Political Science.