Equity index providers' efforts to crack down on the inclusion of shares with limited voting rights into benchmarks are being welcomed by emerging market investors - even if the changes end up expelling some of the developing world's biggest firms. Slashing the index weighting of firms whose unequal voting rights can favour their founders or governments tightly holding onto the reins, would be a powerful measure, potentially depriving them of a pool of money from passive investors aligned with those benchmarks.
Shares with unequal voting powers were out of fashion and even banned in some jurisdictions for decades after World War Two but the growth of tech giants such as Facebook or Google parent Alphabet have seen such structures become popular again. A number of indexes across major developed markets, such as S&P 500, have already started excluding firms that issue multiple classes of shares - such as ones that do not allow votes on major corporate decisions or the make up of the board.
Now index provider MSCI is proposing a firm's weighting in some developed and emerging indexes should reflect shareholders' voting power as well as freefloat. Under the proposal, stocks that offer holders no voting rights would be deleted, those that restrict voting rights would be trimmed.
The issue is more prevalent in emerging markets which fund managers say is due to the sheer weight of tech firms such as Samsung in the indexes, along with state-controlled firms such as Brazilian oil-giant Petrobras. Fund managers said the move was essential to address the imbalance which developed as the growth of passive investing encouraged companies to sell non-voting shares that index-tracking investors were forced to buy.
Passive investors are at the forefront of those urging a change. "One of the most foundational principles in corporate governance is the alignment of voting rights with economic interests," said fund manager Vanguard, whose Vanguard FTSE Emerging Markets fund ETF has more than $73 billion under management - the largest emerging equity ETF in the world.
Vanguard said it had talked to a range of companies over the past year to raise concerns over multiple-share-class structures that create disproportionate voting for certain shareholders. "Vanguard strongly believes that one share should equal one vote," according to an emailed statement from the firm whose flagship emerging markets ETF tracks the FTSE Emerging Markets All Cap China A Inclusion Index.
MSCI's proposal would lead to a bigger shift across emerging indexes, where the number of unequal voting stocks stands at more than 13 percent of constituents compared to 8.5 percent in its world index. If implemented, five emerging market companies will be deleted altogether: telecoms group Etisalat, Russia's Transneft preferential shares, Mexico's franchise bottler Coca-Cola Femsa as well as Brazilian retailer Grupo Pao de Acucar SA and pulp and paper firm Suzano Papel e Celulose SA.
Another 88 would see their weighting cut. MSCI is seeking feedback until the end of May, with results out by June 21. While FTSE Russell already had proposed introducing a voting rights threshold, this applied only to developed markets, arguing it might be "unreasonable" to hold emerging market firms to the same standards as developed peers.
Investment bank Renaissance Capital estimated that across all emerging markets and benchmarks, some 40 percent of funds were now passive. Looking at those benchmarked against the MSCI emerging market indexes, nearly a quarter of assets are passive. "All they have to do really is track the index," said Dan Salter, head of equity strategy at Renaissance Capital.
"(But) as their funds get bigger and bigger, and more and more pension funds are invested in them, and they become more systematic or systemic within the investment community, there is more pressure from society as a whole that ETFs should act to defend the interest of the underlying shareholders or the holders of the ETFs." Implementing the MSCI proposal would also see some countries' weighting decrease in the EM index. Of the 93 impacted stocks, 31 are in South Korea and 18 in Brazil.
Implementing the changes should make issuing companies think twice about their chosen structure, said David Smith, head of corporate governance-Asia at Aberdeen Standard Investments.
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