Korean Transaction Tax will dent country's hedge fund ambitions

23 Aug, 2012

Proposals in South Korea to implement a transaction tax on futures and options would seriously dent the jurisdiction’s ambitions to build a viable hedge fund industry, it has been warned.

Korean tax is another stumbling block for country's embryonic hedge fund industry

The Korean Ministry of Strategy and Finance has announced a proposed 0.001% tax on Kospi 200 Index futures transactions and a 0.01% tax on Kospi 200 Index options trades. The proposal is open for consultation until September 18, 2012 while authorities hope to implement the rules from January 1, 2016.

The transaction tax comes at a delicate time for South Korea as it is trying to develop an onshore hedge fund industry. South Korea recently revised its Capital Market Consolidation Act to make it easier for managers to set up shop in the country. However, uptake by managers has been slow with just 17 domestic hedge funds launching, which collectively manage less than $500 million. The latest proposal could jeopardise this even further.

“The proposed derivatives tax in Korea would, if implemented, slow the level of trading since some traders might well look to trade offshore if similar derivatives products are available in overseas markets without taxes on trading.  The proposed tax would definitely slow the development of the hedge fund industry in Korea. It would add to the costs of trading for hedge funds and other funds in Korea that use derivatives and thus in most cases would lower returns for investors,” said Hank Morris, an advisor for North Asia at Triple A Partners, a Hong Kong-based third party marketing firm.

Tough, pre-existing regulation has also hindered the evolution of the embryonic domestic and foreign hedge fund market in South Korea.  Managers hoping to obtain a fund management license are subject to stringent regulatory capital requirements. Meanwhile, naked short selling is prohibited while the authorities have repeatedly banned short-selling of financial stock altogether during bouts of market volatility with the last ban only expiring in December 2011. Furthermore, the country already has a tax ranging between 0.3% and 0.5% on equity transactions.

“Korean fund managers who want to manage hedge funds have located their companies in Hong Kong and Singapore and have taken residence there as well. Any complications on the tax side that might hinder their returns would be one more reason for them to remain overseas rather than to return home to set up their funds in Korea,” added Morris.

The rules will also scare off foreign managers which had considered domiciling in South Korea. “For foreign fund managers who are interested in managing hedge funds focused on Korea, these taxes may be yet another reason that they will prefer to domicile their funds outside Korea and manage them from some other jurisdiction as well,” said Morris.

If enacted, the government predicts the transaction tax could generate 100 billion won (or a paltry $88 million) in revenue. “Eighty eight million dollars is minimal revenue. It could cost the authorities and firms more to implement the infrastructure,” said Simon Andrews, director of commodities at the Futures and Options Association (FOA), the industry body representing firms engaged in derivatives trading.

Hong Kong and Singapore are unlikely to emulate South Korea’s transaction tax despite the latter clamping down on its own $53 billion hedge fund industry. “Hong Kong and Singapore will resist calls for such taxes since they stand to benefit from a greater level of business that will flow into their markets from investors and fund managers who will be seeking to trade in markets with lower tax structures,” said Morris.

South Korea’s proposal comes three weeks after France enacted its own 0.2% transaction tax on listed equities with a market value of more than €1 billion. Experts predict there will be a surge in equity swap transactions in France as broker dealers and asset managers seek to circumvent the tax.  “I expect French broker dealers and asset managers will mimic what their counterparts did in London when the UK introduced a stamp duty on share transactions, and trade more synthetics,” said Andrews.

There are still concerns that a Financial Transaction Tax, albeit a significantly watered down version, could become EU-wide.  “There is a talk of a transaction tax or stamp duty style tax being implemented by some member states using enhance cooperation procedures (ECP). However, use of ECP would require pan-EU agreement. Non-participating member states, such as the UK, would also need reassurance that any tax would not detrimentally impact their own economic interests,” commented Andrews.

derivativesequity swapsEUFinancial Transactions TaxFutures and Options AssociationSouth Koreastamp dutyTriple A Partners