Prepared Remarks of CFPB Director Rohit Chopra at Harvard Law School on the Asset Management Oligopoly

Thank you to Harvard and Oxford for hosting this conference to explore the repercussions of concentrated ownership and control on sectors of the economy.

Today, I want to explain how natural monopolies and oligopolies have emerged in the asset management industry, especially with respect to equity ownership and control of companies across the U.S. economy. Then, I want to outline how consolidated ownership and control is raising concerns for U.S. banking regulators. Finally, I want to detail a recent proposed rule I put before the Board of Directors of the Federal Deposit Insurance Corporation to address some of the concerns, as well as some other policy considerations.

As always, my remarks reflect the views of the Consumer Financial Protection Bureau and do not necessarily represent the views of any other component of the Federal Reserve System.

Natural Oligopoly

An enormous amount of equity ownership is now concentrated with a small set of financial firms. A review of public filings with the Securities and Exchange Commission reveals that this small group owns major stakes in public companies throughout the U.S. economy. For example, BlackRock manages $10.6 trillion in assets and Vanguard manages $9.9 trillion in assets.¹ For both firms, a substantial portion of assets under management are held in equity funds that track a diversified index.

There are many drivers of this trend. First, modern portfolio theory has influenced investment allocations away from active management of individual stocks and toward broadly diversified index investing. Second, the decline in defined benefit pension funds and the rise of defined contribution funds in the U.S. has created more momentum for investment firms to create diversified index investment vehicles. Third, while not infinite, there are clear returns to scale in managing buy-and-hold investment funds, giving the very largest players an advantage in attracting further capital.

In many ways, this small set of firms is a natural oligopoly, and absent some sort of subsidy or policy change, a durable one that would be difficult to disrupt. This gives these firms an extraordinary amount of power to impose their preferences and regulations on businesses throughout the economy.

There are two terms that are often used (and misused) in discussions about the asset manager oligopoly: "passive" and "active." We typically make a distinction about whether an individual household has a passive or active investment strategy. If they are passive, they typically allocate their money in a diversified portfolio and hold. If they are active, they often work with a financial advisor or on their own to initiate trades of specific investment opportunities, buying and selling based on new information.

This is, of course, different than passive or active ownership. A completely passive owner of a company may have little to do with the day-to-day operations and management of a firm. However, we have long recognized that a passive owner might still have a great deal of control and influence. Even without voting or serving on the board, the board and management will be highly responsive to the owner's goals. Indeed, many laws and regulations around the globe explicitly contemplate levels of ownership that automatically trigger presumptions of control. Absent some sort of specific restraints, managers will naturally respond to the major owners of the company employing them. Those with major stakes typically can't credibly claim that they have no influence, even as absentees.

Regardless of this distinction, we know that major asset managers are not even passive owners and are taking steps to exert control. Rather than say they are exerting control or influence, they tend to describe their activities with different terminology. For example, they employ squadrons of individuals on so-called "stewardship" teams.

These teams conduct thousands of engagements with corporate executives behind closed doors to share substantive views on priority areas and to solicit more information from firms. They also publish white papers on their engagement priorities, participate in industry conferences, and conduct press tours. Importantly, they also analyze proxy statements to determine voting of their sizeable shares. On the merits of their "stewardship," I sometimes agree with the positions they advocate, like when it comes to certain governance issues. But these asset managers and the power they wield has raised serious concerns from a broad spectrum of policymakers.

Concerns for Financial Regulators

This brings me to specific concerns about concentrated ownership within particular sectors, like banking. In the U.S., we have a strong tradition of the separations between banks and other businesses in the real economy.

Banks are chartered by federal and state governments and given a host of special public privileges. They issue deposits, the primary form of money in our economy, and those deposits fund loans to households and businesses. Because people may want to withdraw their deposits on demand, and bank assets are tied up in illiquid loans, banks are authorized to participate in federal deposit insurance programs. Deposit insurance gives people confidence they can get their deposits back even if the bank goes belly up.

While most economists primarily focus on the Federal Reserve's role as a price-setting agency that manages the price and supply of money, the agency also serves as a special gateway for chartered banks. Unlike other companies, banks are allowed to have an account at the Federal Reserve, which lets them move money in ways that others can't. And importantly, when a bank needs cash in a crunch and they can't find money anywhere else, they can borrow from the Fed directly by pledging their illiquid loans or other assets at what's called "the discount window."

By transforming deposits into loans and by providing access to payment systems, banks are as essential to the economy and society as our transportation network or our energy grid. Most households and businesses are hooked up to them. And when they stop working, everything else does too.

Because of their special role and access to government privileges, we must be careful not to allow banks to commingle with other commercial enterprises. If they did, this would give those companies an unfair advantage in accessing and allocating financing that wouldn't be available to their competitors, among other issues.

I will not provide a detailed recounting here of the range of concerns that have been raised regarding large asset managers controlling banks across the country. At a high level, concentrated ownership can undermine competition in the banking sector in a way that reverberates throughout the economy, increase risk-taking on the back of publicly insured deposits, and create fundamental conflicts of interest that leave our system of money and credit vulnerable to abuse. The evidence of the harms from concentrated ownership in sectors, including banking, is substantial and growing.²

Revisiting "Passivity" Agreements and Regulatory Deference

Like other critical infrastructure or regulated sectors, the U.S. puts into place certain requirements for changes in ownership and control when it comes to banks. When the investor crosses an ownership threshold, typically 10%, the investor must file an application with the appropriate bank regulator or rebut in writing the notion that it has the power to control the bank. One of the ways that large asset managers comply with this requirement is by entering into so-called "passivity" agreements with regulators.

These arrangements generally set expectations around how large asset managers can avoid exerting influence or control. In my view, the existing agreements are flimsy.³ The FDIC recently notified large asset managers that they can no longer rely on these old agreements. The agency is willing to negotiate new agreements that ensure these firms are actually remaining passive. This area of work has enjoyed broad support from the FDIC Board of Directors, and my fellow board member Jonathan McKernan has been particularly helpful in working to change the agency's approach.⁴

While shoring up passivity agreements is critical, there's also another problem. In 2020, the Federal Reserve issued a new policy expanding the types of activities and investment fact patterns that would not be considered as exerting control.⁵ For example, an agreement struck after the new policy was finalized permitted a large asset manager to serve as a member of the board of directors of a bank holding company while still being considered "passive."⁶ Many stakeholders continue to find this policy quite weird.

For many years, the FDIC deferred to the Federal Reserve Board when it reviewed a change in control notice from an investor that crossed the 10% ownership threshold for an FDIC-supervised bank by purchasing shares of the bank's holding company. The vast majority of banks in the U.S. operate through a holding company structure and issue shares to investors out of the holding company. But the 2020 pronouncement by the Federal Reserve Board and certain other decisions have provided cause to question that deference.⁷ To ensure that we are not abrogating our statutory responsibilities, the FDIC Board adopted my motion to propose for notice and comment a rulemaking that would ensure that investors with substantial stakes in holding companies of banks supervised by the FDIC would still need to follow the agency's procedures.⁸

It is important for people to have easy and affordable ways to participate in index investing without assigning excessive amounts of ownership and control to a small set of asset managers. Beyond the low-hanging fruit of considering concentrated ownership in matters related to changes in control or mergers, many of us across government are actively considering holistic remedies to this problem, including:

• Whether there should be size limitations for asset managers, which would limit the ability of a dominant asset manager to impose private regulations on the economy.
• Whether there should be limitations on asset managers' discretionary participation in proxy voting.
• Whether there should be stricter limitations on how asset managers secretly communicate or influence management.
• Whether to revisit the Hart-Scott-Rodino Act's regulations implementing the exemption for passive investors.

Conclusion

It will be critical to preserve the benefits of portfolio diversification without creating harmful concentration. The laws of our country rightfully create separations and ownership limits for firms operating in critical sectors of the economy. As more and more sector regulators question whether large asset managers are truly "passive," we must continue to develop policies that guard against coercive influence and conflicts of interest.⁹

Thank you.

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