Back in 2012, two international business organisations came together to explain their concerns with and opposition to the newly proposed Financial Transaction Tax (FTT), those organisations were Business Europe and BIAC.
Their concerns were as follows:
“So why is Business so concerned about an FTT? The reasons are many but principally the concern is that if the object is for “the financial sector to make a fair and substantial contribution towards paying for any burdens associated with government interventions, where they occur, to repair the financial system or fund resolution, and reduce risks from the financial system” then the FTT isn’t the right mechanism. The FTT will reduce the number of transactions and hinder optimal reallocation of assets by adding a cost to each transaction. As a consequence of this “sand in the wheels”, risk will increase and investors will require compensation. This will increase costs and will make corporate investments more expensive. There are many examples of this, some of which are surprising.”
FTT is applied at the “small” rate of 0.1% of the transaction value – the consideration paid – to both sides of the transaction so this is actually 0.2%. It is applied to a transaction in shares or bonds (after their issue) and so is applied to the principle. It is also applied to derivatives this provides issues for the real economy. For instance pension funds will change their portfolio of assets over time to manage risk, match their assets to the liabilities they have and adjust their portfolio to the changing yields of the assets contained within the fund. Estimates in both Sweden and the Netherlands indicate that the impact on the value of a pension fund over a 40 year period could reduce the final pensions paid by the fund by 5%. The same issue would apply to an investment vehicle which tracked the share index in a country and backed this with actual shareholdings, FTT would be due on each transaction and the fund would, like the pension fund bear the full cost if it initiated the transaction. Do these seem unlikely targets given the objects of the tax?
Corporates and other Financial Institutions (FI) (e.g. pension funds, insurers, and asset managers) are less able to relocate volumes outside of the EU than banks or hedge funds. The introduction of an FTT has been estimated to result in between 70-75% of tax eligible volumes migrating outside the EU tax jurisdiction. The majority of those volumes will rest in highly mobile counterparties such as bank dealing desks and hedge funds, whereas corporates and other FIs may only be able to relocate roughly 30-40% of their Exchange volumes due to their reduced ability to run treasury functions outside their home locations.
For taxed transactions it is likely that all or most of the tax levied will be passed on to end users. Studies have shown that as much as 90% of the additional tax burden on FIs is generally passed on to end users. In the case of the EU FTT proposal, given the direct costs increase by between 1 and 18 xs what the broker-dealer actually earns on the transaction, the costs cannot be absorbed by the banks.
An example is the most liquid swap product which is the EUR/USD 1 week swap with a notional of €25,000,000 principal. The current cost to transact to the end user is €279; the additional taxation of this transaction at 0.01% is €2,500 to the dealer as well as an additional €2,500 to a Financial Institution (FI) counterparty resulting in a total cost of €2,779-€5,279 or an increase of 9 to 18x the current cost. Swaps of this nature with a maturity less than 1 week, account for over 50% of the cash and derivative markets and therefore will see a significant increase in transaction costs
A target of the tax is high frequency trading, but will it be caught? The majority of high frequency trading activity in the currency markets is in the spot market. It is estimated that only roughly10% of total notional turnover in the cash and derivative markets relates to high frequency strategies. Hedge funds are responsible for the majority of high frequency trading, however they are highly mobile and can relocate transactions outside the EU tax jurisdiction. Estimates suggest a possible 80% relocation of hedge fund related volumes involving at least one EU domiciled counterparty (up to 70% of EU based funds and 100% of Non-EU domiciled funds).
To some extent, this increase in cost can be avoided if transactions are shifted out of Europe but then the objective of the proposal will not be met, as the Commission concluded above. The experience of Sweden in the 1980s in introducing an FTT was disastrous for Sweden (and very beneficial for London as a financial sector) although the EC proposal is drawn widely and would apply to a transaction with an entity in a country which introduced FTT, it would not tax group transactions where both legs were completed outside the country and transactions could be structured in this way.
Some have suggested that the issues from the Swedish experience can be corrected by different implementation – this seems unlikely. Some compare FTT to UK stamp duty; this is a false comparison in terms of which transactions are subject to stamp duty and the mechanisms which are tolerated in the UK on which it is not imposed. Stamp duty is a tax on some transactions but not all.
The European Commission has analysed where the burden of the tax will fall and what the effect on GDP will be, and this is key. The FTT is born by the customers of the Financial Sector: businesses, individuals, pension funds, pensioners and buyers of financial products. The EC’s Impact Assessment is that an FTT could reduce GDP by 1.76% at a time when all politicians are searching for a recipe to stimulate growth. Some delegates of the recent ECOFIN meeting questioned whether the costs would not be even higher. There are suggestions that a new Impact Assessment may suggest that an FTT will be positive for European economic growth! If the proposition that a tax raising euro 57bn per annum increases growth is serious, then I think we have to start questioning the robustness of European Commission Impact Assessments.
Given the delicate state of the European and Global economies, tax policies should be designed to stimulate growth while raising the tax revenues that are needed. FTT will not stimulate growth – indeed it will slow growth and recovery. There may be aspects of activity in the Financial Sector which merit attention, but great care needs to be given to using the best policy instrument and regulation may be a more effective and targeted tool than tax. If tax is to be the instrument, then the advice to the Commission from Taxud was clear: “there is greater potential for a Financial Activities Tax (rather than an FTT) at EU-level. This option could deal with the current VAT exemption of the financial sector and raise substantial revenues.” “
Let us fast forward to June 2013 and the current state of play.
We were concerned about the impact on business as opposed to the financial sector and pointed out the costs on basic business transactions like hedging which is crucial in managing external risks, now as quoted in the FT:
“Proposals by 11 eurozone countries for a FTT on trading in bonds, shares and derivatives have run into strong opposition from the financial industry, which has warned they could dry up markets, increase costs substantially for investors and erode bank profits. “
“Publicly, the ECB has refused to take sides, pointing out it has no mandate in the field. But its offer to “engage constructively” in the design of the tax suggests that, privately, it has deep reservations about its impact on financial markets and the real economy.”
“The ECB is looking especially carefully at the FTT’s impact on bond trading and the market for “repos”, or repurchase agreements, by which assets such as government bonds are sold temporarily for cash and are an essential source of daily liquidity in the financial system.”
On business itself, “ German Industrial companies have warned about an increased cost to transactions essential for their businesses – as well as the impact on company pension fund returns. Even among the 11 countries that have backed a European FTT there are fears it would drive up borrowing costs, already painfully high in southern Europe. Including sovereign debt is “a major concern”, says Ferdinando Nelli Feroci, Italy’s EU ambassador. “We cannot afford the risk of a situation whereby the tax … leads to a situation where yields on sovereign debt may rise.””
We pointed out the impact on the repo market and again as reported in the FT:
“Last month, Jens Weidmann, president of Germany’s Bundesbank, warned that in its current form the FTT “would cause considerable harm to the repo market”. If it was not able to function properly central banks would “remain heavily involved in the redistribution of liquidity among banks long after the crisis is over”.”
“The ECB believes markets should efficiently “transmit” changes in interest rates to the real economy. It would almost certainly back exempting the repo market from the tax, as well as steps to ensure costs did not increase for businesses using derivatives when hedging conventional trades.”
“Richard Comotto, senior visiting fellow at the ICMA centre at Reading university. “The idea that everything short term is speculative is nonsense. People have to keep liquid assets in order to react to the uncertain situation.””
“Godfried de Vidts, chairman of ICMA’s European repo council, said the market was “about a safer way of doing business” and “makes the market function in the way they have been designed to function by regulators”.”
We noted the impact on pension funds and thence on pensioner returns and living standards, no one h
as refuted this.
We opposed the introduction of a tax with extra-territorial impact. Again the FT:
“But Brussels’ proposals, which the European Commission estimates would raise €30bn to €35bn a year, are exceptional in their scope. The aim is to prevent the avoidance that undermined previous European FTTs, such as Sweden’s during the 1990s.”
No matter where in the world a transaction took place, it would be taxed if either party were in the FTT zone. Financial products issued in an FTT country would be taxed even if the traders were based elsewhere.
There are a host of technical headaches, too. Because the tax would be liable wherever assets from FTT countries are traded, Europe would be relying on authorities elsewhere. Opponents question how effective tax collection would be when, say, US or Japanese banks traded German equities.
Washington staunchly opposes the tax and Congress could retaliate with a law to ban US financial groups from paying it. The tax is “unbelievably objectionable”, says Kenneth Bentsen, president of the Wall Street lobby group Sifma, adding that it is unclear whether European authorities have the right to collect it. “
So where will we end up?
Special treatment for the repo market seems inevitable, either through exemptions or much lower tax rates. The dilemma in Brussels is that a less ambitious UK-style “stamp duty” would hit retail products such as equities while sparing the complex derivatives that are the FTT’s main target. “They are searching for a graceful exit but it isn’t easy to find,” says one senior EU official.
“The wonderful irony is that it is the UK which has the best example of an FTT,” says Prof Persaud. “Low transaction costs in finance are good – but zero is not desirable. There is a middle road with a low tax that raises modest revenues but does eliminate some of the excesses.”
All eyes are on Germany, which has no stamp duty. Its original zeal has waned. German officials privately raise technical questions about implementation. “We are just beginning this discussion. It is not a major concern to be very frank,” Wolfgang Schäuble, Germany’s finance minister, admitted recently.
In none of our comments can we be accused of crying wolf or exaggerating issues and impacts. The critique of the design and its impact was measured and has been borne out by current concerns of a wide number of commentators. Business should continue to oppose the current proposal.