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Vanguard has agreed to increased oversight of its investments in certain American banks, prompted by regulatory pressure, marking a significant development for both money managers and banks. This new arrangement, revealed by the US Federal Deposit Insurance Corp (FDIC) on Friday, grants Vanguard’s funds the ability to maintain large stakes in a wide range of US banks. Simultaneously, it enhances the FDIC’s supervisory control over the $10 trillion asset manager.
Vanguard, alongside industry giants like BlackRock and State Street, has accumulated substantial shares in US banks due to the surge in popularity of “passive” funds, which broadly invest in a wide array of stocks. This has led to concerns among some regulators and politicians about these large fund managers wielding undue influence over critical economic entities.
Jonathan McKernan, an FDIC board member who has advocated for more stringent control over fund managers’ influence on banks, remarked, “The passivity agreement Vanguard entered today should enable the FDIC to tackle the concerns I’ve raised since January about gaps in our monitoring of purported passivity among the largest index fund complexes.”
Under the new agreement disclosed on Friday, whenever Vanguard owns more than 10% of the shares in a larger variety of lenders than before, it will need to file passivity agreements with the FDIC. This includes not just standalone FDIC-supervised banks but also those owned by bank holding companies.
However, this deal doesn’t apply to investments in the largest US banks such as JPMorgan Chase and Bank of America, which are under Federal Reserve regulation. It does, however, pertain to several mid-sized and regional lenders where Vanguard holds a substantial share.
The agreements ensure Vanguard pledges not to influence banks’ operations, such as steering them towards lending to certain sectors like sustainable energy.
The timing is critical, as this agreement arrives just before a December 31 deadline set by the FDIC for Vanguard and BlackRock to comply or face legal challenges. BlackRock and other industry groups have opposed these new restrictions, arguing that they would unnecessarily increase compliance costs and diminish the appeal of bank stocks as investments.
Some firms have also questioned the FDIC’s authority to dictate their investment strategies. Nonetheless, Vanguard has taken a cooperative approach, engaging with regulators over the past year on this issue.
Traditionally, index funds are required to be passive, particularly concerning banks. Generally, regulators have allowed fund managers to certify their passive stance without external validation.
Now, these new passivity agreements establish an FDIC-supervised monitoring framework to enforce compliance. Vanguard retains the right to vote on shareholder decisions at annual meetings but is clearly prohibited from influencing banks by nominating directors.
In a statement, Vanguard emphasized its dedication to passive investing, stating, “Vanguard is built around passive investing and has long been committed to working constructively with policymakers to ensure that passive means passive. This agreement with the FDIC is another example and recognition of that ongoing commitment.”
Initially, the FDIC set an October 31 deadline for Vanguard and BlackRock to agree to these terms but extended it twice.
As for BlackRock, neither the FDIC nor the firm has clarified whether a similar agreement is anticipated before the deadline. BlackRock did not respond to requests for comment following the announcement of Vanguard’s agreement.
State Street, being more closely regulated as a bank, is not subject to these passivity rules.
