Proposed EU Financial Transaction Tax slammed by industry experts

Fund AdministrationInvestorsLegalOperational RiskRegulation
18 Jan, 2012

Industry organisations and market commentators have slammed the European Union’s (EU) proposed Financial Transaction Tax (FTT) arguing it could undermine the single market and force financial institutions to leave the EU.

The FTT or “Tobin Tax” could lead to a significant decrease in cross-border trading of financial instruments in the EU thereby destabilising the single market, said the Alternative Investment Management Association (AIMA), the hedge fund industry body.

“Our analysis concludes that the EU’s proposed FTT will reduce or eliminate a vast amount of cross-border share and bond trading activity within the EU, thus undermining the single market. And we are not talking about complex financial transactions but very simple buying or selling of shares undertaken by ordinary investors. This could have very serious unintended consequences - including a further tightening of financing conditions for business - at a critical moment for the European economy,” warned Andrew Baker, chief executive officer at AIMA.

This could force business out of the EU into potentially less transparent jurisdictions, which in turn might lead to increased systemic risk. “Studies examining similar tax levies introduced in the past in various jurisdictions reveal significant and irreversible trade migration away from the countries implementing the tax,” reads the AIMA study.

“Sweden, which introduced a similar tax on financial transactions in the mid-1980s, saw an exodus of business to London. Not only will it lead to a migration of talent but the EU’s proposed FTT will disproportionately hurt smaller businesses. The larger banks and hedge funds can simply move to jurisdictions with friendlier regulations. But smaller firms do not have that luxury and will suffer,” said Simon Andrews, director of commodities at the Futures and Options Association (FOA), the industry body representing businesses engaged in derivatives trading.

Dermot Butler, chairman of Custom House Group, an Ireland-based fund administrator agreed the EU would be worse off with the FTT. “If some eurozone economies impose the FTT, banks and investment managers will simply move to London or Singapore. The US has said it might push through a similar law although I doubt it will ever see the light of day. If France goes ahead and unilaterally imposes its own FTT, business will just move across the Channel,” he said.

The FTT, which the European Commission (EC) hopes to implement from January 1, 2014, would impose a 0.1% tax on all equity and bond transactions, and a 0.01% charge on all exchange-traded and over-the-counter (OTC) derivatives trades performed by financial institutions. The EC believes the tax will raise between €25 billion and €43 billion in revenues although it acknowledged it would reduce EU GDP by anywhere between 0.53% and 1.76%.

These figures have been heavily disputed by Ernst & Young (E&Y), which said the FTT could leave a €116 billion hole in EU governments’ public finances. E&Y said the EC’s numbers were based on optimistic assumptions about the likely decline in trading activity once the FTT is introduced. The EC also failed to take into account the fall in other tax revenues that would arise from lower GDP growth, according to E&Y.

The proposals would also lead to unintended risks. It could undermine sound asset management practices such as diversification, proper hedging and efficient execution. It incentivises investment in riskier alternatives such as synthetic derivatives forcing asset managers to undertake greater risks to deliver the same level of returns to their investors as they had done previously. This would impact pension funds and conservative fixed income portfolios. “There would, therefore, be the potential for such risk management procedures to leave market-makers with higher risk, increasing spreads in the markets and declining liquidity, all of which would undermine the FTT’s ability to raise revenue sufficient to compensate for other lost taxes,” reads the AIMA report.

Ultimately, end investors would bear the brunt of the pain. “Pension funds and the real economy will suffer from the imposition of the FTT,” stressed Andrews, something AIMA also reiterated. “Studies indicate that a FTT could also lead to a reduction in the level of investment in the real economy and discourage corporate governance and long term engagement because investment managers would invest less in equities and more in derivatives as a result of the bias in the proposed rates. Again, as a result the investment performance of pension funds could suffer considerably,” reads the AIMA study.

Apart from hurting investors, destroying liquidity and undermining the single market, the FTT would force asset prices down, widen spreads, hinder efficient price discovery and increase market volatility. This is at a time when questions are being asked about the sustainability of the eurozone with many commentators anticipating an eventual break-up of the bloc. “This is an intensely political piece of regulation being put forward by the French and Germans and it is incredibly irresponsible in this precarious economic environment,” warned Butler. A global FTT, despite the damage this would do worldwide to financial institutions, would at least mean that all market participants are on a level playing field. However, “introducing an FTT on a unilateral, EU-wide basis appears to carry very substantial risks which the EU financial sector and the EU economy may find it difficult to recover,” warns AIMA.

The likelihood of this legislation ever seeing the light of day is remote. In its existing form, the regulatory costs would be too great for EU regulators to stomach, while affected businesses would probably ditch the EU altogether making the whole experiment totally unsustainable. Furthermore, the British have vetoed the entire deal and other countries such as Sweden may follow suit. “I doubt anyone will be as stupid as the French and Germans to impose this rule,” concluded Butler.