Angeli Arora analyses calls on fund managers to offer pass-through voting in their pooled funds. She evaluates how pass-through voting helps ensure that public companies improve their sustainability efforts in line with societal expectations. She also highlights the important legal issues fund managers need to address when implementing these products.

 


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Investors’ Call For Voting Changes Faces Practical Challenges

by Angeli Arora

On Dec. 8, 2023, an investor coalition collectively representing approximately £250 billion ($314.5 billion) of assets under management issued an urgent call on fund managers to ramp up their efforts to offer pass-through voting on their pooled funds.[1]

Their view is that pass-through voting will better ensure that public companies improve their sustainability efforts in line with societal expectations. However, fund managers have a number of complex legal, regulatory and technology-related hurdles to navigate in order to bring this product to market.

What Is Pass-Through Voting?

Pass-through voting is where investors in a fund are able to vote — or give an indication of how they wish to vote — the underlying shares held by their fund, in proportion to the amounts they have invested in the fund.

In effect, the fund manager votes the shares in a public company held by the fund in accordance with, or taking into account, the wishes of the investors of that fund.

By way of example, Ms. A, Ms. B and Ms. C invest £10 million each in a fund, so the fund has £30 million of assets under management. The fund owns 90 shares in XYZ PLC.

Usually, the fund manager would vote the 90 XYZ shares as it thinks fit, taking into account the fund mandate. However, with pass-through voting, the fund manager would vote 30 XYZ shares in accordance with the wishes of Ms. A, 30 XYZ shares in accordance with the wishes of Ms. B, and 30 XYZ shares in accordance with the wishes of Ms. C.

Investor Coalition Argues Pass-Through Voting Is Desirable

Funds currently control a large proportion of the shareholder votes in public companies. As the investor coalition’s letter explains, “globally, the data shows that the three largest fund managers currently cast approximately 23% of the votes at companies in the S&P 500, a percentage projected to rise to 40% by the mid-2030s.”[2]

Shareholders, through the exercise of their voting rights — including the Draconian right to remove directors by ordinary resolution, exert considerable influence on how their companies behave.

However, fund managers vote the fund’s shares in companies in accordance with a set of objectives that are narrower, and arguably more focused on financial returns, than societal expectations of public companies.

As a consequence, shareholders — largely comprising funds — hold companies accountable for their financial performance but fail to hold these companies adequately accountable for their wider impact in society.

It is hoped that pass-through voting — offering the ordinary person, who invests in funds, a greater say in how the fund manager votes the shares the fund owns — would result in fund managers better reflecting the wider concerns of the ordinary person. This includes around societal issues, when voting the underlying shares in public companies, and in turn, creating shareholder pressure on public companies to improve their sustainability efforts.

Calls for pass-through voting are not new. For example, the Asset Management Taskforce advocated in favor of this general principle back in 2020 in its paper titled “Investing with Purpose.”[3]

However, funds have been slow to develop an offering that allows them to better reflect their investors’ views when voting shares held by the fund.

The investor coalitions’ letter impresses a new sense of urgency on funds to step up their efforts, pointing to the worrying trend in 2023 of growing misalignment between what society expected in terms of their nonfinancial performance and what shareholders were asking of public companies.

The letter notes that while in 2023 the United Nations and Intergovernmental Panel on Climate Change were calling for plans to be accelerated to ensure the goals of the Paris Agreement are met, conversely, there were decreasing levels of support for shareholder proposals, including on climate-related issues.

The underlying message of the investor coalition’s letter is that the ordinary person, investing in a fund, needs to have a greater say — through pass-through voting — in how the underlying companies owned by the fund are held accountable in relation to their sustainability efforts, if public companies are to take the urgent actions required of them.

Practical Issues

However, while the investor coalition is clear on the increasing urgency for funds to offer pass-through voting, the work involved in bringing an effective product to market should not be underestimated.

It requires funds to grapple with a number of legal, regulatory and technology issues, including how investors’ views are collated and what restrictions should be placed on the investors’ ability to direct how shares of the funds are voted.

For example, investors cannot require a fund manager to exercise the votes of shares held by the fund in a manner that conflicts with the mandate of a fund.

Otherwise, the fund manager would potentially find itself in breach of its fiduciary duties, e.g., its tortious duty to exercise due skill, care and diligence; its legal and common law fiduciary duties deriving from its legal structure; its contractual duties set out in the fund documentation; and its regulatory duties, including under the Financial Conduct Authority handbook.

Consequently, pass-through voting needs to be structured so that it allows fund managers to retain ultimate discretion in terms of voting the shares of the fund, so that their duty to pursue the best long-term interests of the fund, taking into account the purpose of the fund, is not compromised.

Funds have been exploring a number of ways to do this, from providing an ability for fund managers to override the wishes of investors in limited circumstances, to asking fund investors to choose prescribed positions or policies on shareholder resolutions, e.g., resolutions related to climate action or governance.

In effect, fund managers need to strike a balance between offering a product that allows investors in a fund to give meaningful input on shareholder matters while allowing the fund manager to perform the mandate of the fund.

Funds also need to consider how a number of FCA rules and regulations affect pass-through voting, including Section 235 of the Financial Services and Market Act 2000, the Collective Investment Scheme handbook Chapter 6.6A.2 and 6.6.13(2), and FCA Principle 6 — treating customers fairly.

However, the FCA confirmed in a public letter to the Department of Work and Pensions in October 2022 a supportive regulatory environment for pass-through voting.

Technology also needs to allow for investor views to be properly collated, and voting technology companies like Tumelo are leading the innovation in this regard.

Conclusion

In summary, the investor coalition’s open letter highlights the renewed concern in the investment community to act faster and more decisively in putting the interests of clients at the heart of stewardship by offering pass-through voting — particularly given the increasing misalignment in 2023 between shareholder voting in, and society’s expectations of, public companies.

However, funds must work through the legal, regulatory and technological issues affecting pass-through voting, to ensure that the risks related to the product are effectively mitigated.

 


Angeli Arora is the managing partner at Allectus Law LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] https://www.moneymarketing.co.uk/news/asset-owners-issue-urgent-call-for-more- control-over-proxy-voting.

[2] https://www.smartpension.co.uk/news-and-media/pooled-fund-voting.

[3] https://www.theia.org/sites/default/files/2020- 11/Asset%20Management%20Taskforce_proof7.pdf.

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