A look at how the impact the Financial Transaction Tax (FTT) has had so far on trading volumes and activities and the concerns for long term impact for the financial markets and its stability in the EU. Lynn Strongin Dodds reports.
The financial transaction tax (FTT) may be on the European Union agenda but it is far from being a done deal. The European Parliament elections are looming and there are still several political and legal issues to overcome. The most likely outcome is a compromise which could take some of the sting out of the trading tail.
The FTT, also dubbed the Robin Hood and Tobin tax, was initially poised to impose a sweeping levy with the rate slated at 0.1% for bonds and shares and 0.01% for derivatives. It was set to make its debut this January but given the political wrangling, it is more likely to be introduced in 2015. There is still dissension in the ranks of the eleven who signed on- Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovenia, Slovakia and Spain – over the nature of the transactions to be covered.
For example, France, the newly elected German coalition government and Italy back the idea of adding currency trades while others are not that keen but would like to see government bonds scratched off the list. Informal discussions were held in mid-January where the so called FTT 11 debated a few of the key features including whether the residence or issuance principle should be adopted, the merits of exemptions for unlisted shares and small caps, public and private bonds and notably a partial exclusion or phased introduction for derivatives. A technical paper also suggested that an exemption for repurchase agreements (repo) and securities lending is under active consideration.
The UK, on the other hand, is against the tax and felt vindicated by the ruling of the EU’s Council Legal Service last September which deemed the policy illegal because it “exceeds Member States’ jurisdiction for taxation” and “infringes upon the taxing competences” of states that have refused to adopt it. The non-binding opinion also noted that the plan “infringes upon the taxing competences of non-participating member states”, making it incompatible with the EU treaty.
The UK had thrown down the legal gauntlet to the European Court of Justice over concerns that the tax would have a significant impact on British firms in the City of London who trade with branches of French or German banks based in the capital. The government would have to collect the tax, but would not be allowed to keep it.
There is a lot of division behind the scene,” says Tony Freeman, executive director of industry relations at Omgeo. “I think the FTT will be rolled out but the lessons from Italy will have been learned. For example, there is already talk that government bonds will be exempt. I do not think that it will happen this year due to the Parliamentary elections because the issues are so complicated.”
Matt Gibbs, product manager at global solutions provider Linedata, adds, “We are waiting to see what the sustained impact of the tax will be on Italy and France. The initial impact on volumes was significant. If you introduce a volume related tax, while other options are available, then the volume will be turned off. Also, the longer the other countries stay out, the greater the opportunities for tax arbitrage.”
Figures from Tabb Group confirm that there is an increasing divergence within the Eurozone between the UK and Italy which introduced the tax on 1 March 2013 on equities before extending it to equity derivatives and France where it took effect on 1 August 2012 but still only applies to equities. The consultancy shows that, France’s 17.1% market share of overall European trading in 2011 – ahead of the FTT – fell to 15.3% % in 2012 and 13.1% in 2013 while Italy witnessed similar declines with its contribution dropping to 4.9% last year from 6% in 2012 and 6.6% in 2013. By contrast, the UK enjoyed a rise to 21.2% from 18.4% over the two-year period.
According to Rebecca Healey, a TABB senior analyst in London, the Italian regulation also
crippled model-driven strategies which resulted in a dramatic shift in market activity. “The Italian FTT charges an additional 10bps for OTC activity. As we predicted earlier this year, clients asked brokers to turn off their routing systems to avoid higher fees in internal dark pools for Italian stocks. Algorithms were to be throttled back, making electronic trading less efficient, with some choosing to step away from the Italian market entirely. Only a decreasing number of Italian stocks will have sufficient liquidity to trade on the lit exchange without incurring market impact. As model-driven trading is driven out of the market, a significant chunk of liquidity disappears – hence the decline to under 5% of overall European market share.
Healey does note though that it is important to look at the bigger economic picture when assessing volumes. “The declines may be attributed to the deterioration of France’s economy and investor appeal rather than due to the introduction of the tax. If these two countries were doing better than the volumes may not have dropped as much. However, if that is the case, then it would be foolhardy to impose such a tax because it deters people from trading on these markets. I think we will see a watered down version because it will be too difficult to reject the FTT entirely.”
Alexander MacDonald, CEO of the Wholesale Markets Brokers’ Association also believes that there will be a redefined proposal. “It is an ambitious tax plan but it is too difficult to implement as an ‘enhanced cooperation’ measure. We are already seeing discussions on whether the residence or issuance principle should be adopted and if corporate or government bonds should be carved out. I think it could end up more like a stamp duty.”
If it is passed in its current form, it may not only impact volumes, but also the financial stability according to MacDonald who points to a new a new paper commissioned by the International Regulatory Strategy Group (IRSG) and authored by Deloitte. It shows that the FTT could tip the balance into market volatility plus pose a direct conflict between the tax and the general regulatory objective of banks strengthening their balance sheets, to the extent that they could bear the significant costs.
Equally as important will be the market fragmentation, which would have adverse consequences across the board but particularly for EU collective investment schemes, such as UCITS, which could see reduced returns. To date, they have been one of the biggest success stories in harmonisation and integration in the market for financial services in the region.
For now, the proposals remain in a state of flux although Greece, the current holder of the EU presidency and Italy, its successor, are both supportive of an FTT and intent on implementation. The weighty €30-35 bn revenue per year, the tax is expected to generate is too tempting to relinquish. However, if the Italian and French experiences are anything to go by, they may be disappointed and the coffers could end up only half full.
