June vote could jeopardise City of London’s future…again!

If Labour defy the odds and win the UK General Election, the FTT would be back on the table, dealing a bigger blow to the City of London than Brexit.

It is over two years since the EU looked at a Robin Hood tax on financial services. The issue could come to the fore again and so it is worthwhile revisiting the implications. The UK Labour Party, although long odds against winning the UK General Election next month, has adopted a policy to implement FTT, if elected, and believe it will raise some £5-6 billion per annum.  Although it appears the EU have kicked this issue into the long grass, 11 EU countries were talking of introducing a Financial Transaction Tax that would have cost the market, if their revenue raising assumptions were right, around €35 billion per annum. And, as that sum would more than compensate for the net revenue loss of a UK exit, a UK initiative would undoubtedly re-energise the proponents of this tax.

In reality, the revenue assumptions of the FTT have always been deeply flawed, for the tax will destroy markets and the revenue take is likely to be less than the cost it creates for the affected economies. Were the UK to adopt the tax bilaterally, together with the stress of BREXIT, it would most likely be the death knell for the City of London as a global financial centre. And pension funds and mutual funds, being less mobile, would be the ones who carried the eventual burden, for like UK stamp duty the cost will always end on the investors’ account. Hedge funds and traders can move to other locations and, although they could still be within the reach of the tax for UK or EU instruments, the structure of the non-cash markets and potential challenges to extraterritoriality by third country Governments makes collection challenging.

In the real world we can assume that FTT will have the, perhaps intended consequence of some in Europe, of destroying several markets. The main one of concern should be the repo market, although the proposed UK Labour party policy appears to exclude government debt. However, the old EU proposal was less clear in this respect. A repo, which is rolled over each working day of the year on a given instrument would produces an added yield of around 0.15% per annum for the investor. If the transaction is subject to FTT, there would be an added UK daily charge of 0.2% (less in the EU proposal) each day or around 50% of face value of the transaction per annum. Thus the repo market is dead. Government yields will come under pressure with an added 0.15% yield needed to retain their position against other non FTT impacted repo eligible government bonds.

Stock lending and borrowing would also be decimated by the tax, especially as it appears that, even on term lending, each collateral substitution would be subject to the tax. The result will be much lower liquidity in the major securities and thus greater market volatility. And, in the UK, liquidity would disappear with the proposal to remove the market maker exemption and thus demand the tax on trading books as well as investment transactions. That alone could add 25 basis points plus to corporate sector yields and widen spreads in equity markets by a meaningful amount. The suggested measure, alongside other proposed Labour party corporate tax increases, would most likely lead to the re-domicile of many major global UK corporations.

Derivative transactions would also be decimated by the historic EU 0.01% and UK Labour party 0.2% proposed tax regime. It has to be remembered that derivatives are moving more and more to SEF trading and CCP clearance. This has led to demand for more collateral. And FTT, over and above the tax rate on the transaction, will apparently also, as for stock lending, levy taxes on many types of collateral, whether an original pledge or repo, substitution or other movement. Each derivative transaction will thus be hit by the tax at multiple touch points to the trade and, on an on-going basis throughout the transaction life cycle, creating a difficult to estimate cost of maintenance.

Getting more tax from financial transactions is a valid objective of Governments. But unilateral action will primarily destroy markets or cause their relocation. The UK, with over £60 billion of Financial Services fiscal revenues, has to be careful its tax does not meet its philosophical ambition to the detriment of the amount of tax raised from the sector as a whole.

At the moment markets are sanguine about the proposal and others from the UK Labour party. Were the opinion polls to change, or the reality on 8 June to be different than expected, we could see market disruption that makes that of the day after the UK Brexit vote appear to be a walk in the park!