Assumptions Versus Realities of Financial Transaction Taxes

There is an undoubted need for governments to raise taxes, and bankers ruefully admit that they will be hit with new levies. These may range from emotionally charged bonus taxes through to more justifiable premiums for the explicit balance sheet guarantees given, especially to systemically important financial institutions.

There is an undoubted need for governments to raise taxes, and bankers ruefully admit that they will be hit with new levies. These may range from emotionally charged bonus taxes through to more justifiable premiums for the explicit balance sheet guarantees given, especially to systemically important financial institutions. There are now apparently ten EU states eager to introduce a financial transaction tax (FTT), and many at Sibos will be debating its consequences, but also, in the transaction banking sector, its modus operandi.

The U.K., as an example, has had a financial transaction tax for many years. It is called stamp duty reserve tax and is levied on investor (as distinct from market maker) U.K. domestic equity market purchases at a rate of 0.5%. It regularly raises around $7-8 billion a year and costs the state almost nothing to collect (as the costs are carried mainly by the U.K. CSD). The EU proposal for FTT is different to the extent that it targets all purchases (with no exemptions) of equities, bonds and some derivatives.

There are several interesting aspects of the EU announcement on FTT. First of all, the tax is cited to raise around 50 billion on the assumption that it is levied at 0.1% of impacted transactions. Second, Belgium is among the ten proponents of the tax, but not Luxembourg. Third, the tax management industry will gear up to minimize the impact. And, finally, it is unclear how the tax will be collected.

The reality is the tax, at 0.1% on transaction flow in the specified instruments, should raise much more than the indicated 35-60 billion per annum. If one questions EU officials on the matter, they apparently believe the tax will limit speculative dealing and therefore reduce transactional volumes sharply. This is a worrying feature, for the estimate of speculative activity is unproven. If the tax is prescriptive and the definition of speculation includes position taking, the question is whether it will kill liquidity and cause (including for governments) a rise in the cost of borrowing.

The inclusion of Belgium and the exclusion of Luxembourg is an interesting aspect of the roll call of intended participants in the tax. If the tax only covers domestic market instruments, the repercussions will not be dramatic. But if it goes beyond such instruments and covers international bonds, the ramifications would be horrific for Euroclear. We should expect exemptions to ensure that the tax does not have such a destructive competitive impact.

And the market will look for ways to avoid the tax. It is difficult to assess how this will occur without having the detailed legislation. But intuitively, there could be a useful byproduct in derivatives whose underlying value is based on the FTT eligible instruments. It would be hard to imagine the tax being able to capture such instruments where the buyer and seller could be outside the scope of the relevant jurisdiction. There could also be new markets for products such as contracts for difference, single-company ETFs or global depository receipts. The potential for flow to exit the location adopting FTT is high in all instruments with sufficient liquidity. And that will cause the adverse price discovery impact noted above.

Finally there are the sheer logistics of collection in a world where there is no universal FTT. There appears a lack of clarity on collection of French FTT when the transaction occurs outside of Euroclear France. Will there be individual payments from each buyer? Will a CSD or exchange registering the transaction be the tax collector? And who will pay for the cost of collection? How is the global transactional activity in the impacted securities monitored and controlled?

As has already happened in France, it appears the tax will be adopted before these questions are answered. The results will be, shall we say, interesting.

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