As the U.S. Securities and Exchange Commission moves to increase its oversight over proxy voting advisory firms, Horizons ETFs is evolving its proxy voting policies to take on a more socially responsible investing position.
“We do have an obligation to our unit-holders to act in their best fiduciary interest, but we also have a socially responsible requirement as well, even as a passive investor,” said Steve Hawkins, the firm’s president and chief executive officer, at an event hosted by the Alternative Investment Management Association in Toronto this week. “So we take an active role in terms of voting those proxies.”
Debates over the role that proxy advisory firms can and should play in capital markets have been contentious, as the rise of major exchange-traded fund providers has brought their influence into sharper focus. Any changes to how proxy advisory firms are allowed to operate will have some impact on their institutional investor clients, but what will that look like?
The SEC’s new guidance, published in August, said proxy recommendations are solicitations because they’re inherently designed to influence a client’s voting decisions. As solicitations, the recommendations are prohibited from containing false or misleading statements regarding any material facts, according to the guidance. As well, proxy firms will have to disclose third-party sources of information and conflicts of interest and have an explanation when third-party information about a company differs from what’s publicly available. Firms will also have to make their methodology for establishing recommendations clear to clients.
An investor’s perspective on a socially responsible investing issue, or any issue for that matter, can be extremely different from the next, noted Hawkins during the AIMA event. For example, Horizons ETFs is supportive of legalized recreational cannabis, as well as the drug’s medical use. “We’re the largest institutional investor in the cannabis space right now.”
Acting on these strong opinions in a significant way through proxy voting demonstrates the power of ETF firms both generally and relative to other investors, said Talbot Babineau, president and chief investment officer of IBV Capital Ltd., also speaking at the event.
“ETFs play a really meaningful role in this . . . . When you purchase an ETF, you’re buying the underlying economics of all the individual securities with it. But what most ETF providers do is they actually strip away those voting rights. They pass on all the economics but not the voting rights, which are maintained at the ETF provider level.”
With the proliferation of ETFs during the past decade, they’ve grown to about US$1.6 trillion in assets, roughly double the size of Toronto’s stock exchange, said Babineau. “What I think is most interesting is that 70 per cent of all assets held under the ETF banner are held by three [providers].”
Such a concentration of shareholding by just three companies could result in a conflict of interest, since the ETF providers may be able to capitalize on the results of their own voting, he said. As ETF providers start becoming involved in active strategies as well as traditional passive ones, the risk of a conflict of interest becomes all the more apparent.
“They way I view it is, they have this unprecedented access to all of the voting outcomes in advance of those outcomes happening,” said Babineau. “So they have this odd ability to front run any investment activity that exists as a result of these voting outcomes, especially around contentious votes. And I’m just not seeing any monitoring.”
Also speaking at the event, Jeff Olin, president and CEO of Vision Capital, called into question whether or not ETF makers should be able to wield that power at all. He also raised the issue of proxy advisory firms’ enormous influence. “Together with enormous power comes enormous responsibility. And frankly, in this role, I think they’re failing dismally and it’s fraught with misalignments in their business models and conflicts of interest.”
ETF providers rely heavily on proxy voting firms, he emphasized. “They are changing the shape of capital markets and transactions that occur.”
These firms often suffer from a serious lack of transparency and won’t discuss their decision-making process with anyone besides their own clients, added Olin. “There’s no feedback, it’s a complete black box, . . . they’re non-responsive.”
This lack of discussion with companies, as well as the rigid criteria used by proxy firms for their analysis, can create scenarios where advisors recommend voting against a company proposal when it isn’t fair to the parties involved, he said.
Amy Freedman, CEO of Kingsdale Advisors, noted institutional investors by no means follow proxy advisors’ recommendations completely. Indeed, there’s some evidence that their influence is waning. “The level of engagement and the adherence to the proxy advisors has begun to dissipate. If you look at the stats, it’s always difficult to figure out what’s causation versus what’s correlation, but you’ll see generally a propensity for supporting management versus not supporting management.”
It’s quite rare to see an instance where the votes taken and the advice from the proxy firm align completely, she added. “The level of engagement has escalated.”