FTT to Hit Corporates and Pension Fund Managers Using FX

Figures from the Global Financial Markets Association (GFMA) reveal that the transaction costs of FX used by corporates and pension fund managers under any proposed Europe-wide Financial Transaction Tax (FTT) will increase by between 300% and 700 % and between 700% and 1,500%, respectively.

The European Commission has excluded FX spot transaction from the scope of the tax but, as GFMA’s Global FX Division (GFXD) points out, imposing an FTT on other FX products heavily traded by these users – specifically FX forwards, swaps, options and NDFs – risks discouraging companies and investors from international trade and investing. “If they continue with international activities, then the impact will be to either see them reduce the hedging of their international activities – with the resultant increase in earnings volatility and business risk – or to take on the additional tax costs that they could otherwise have directed to growth or to delivering fund returns for investors,” said GFMA. “We suggest that these FX Products – FX swaps, forwards, options and NDFs – should, as is already the case in relation to FX spot transactions, be excluded from the scope of any FTT proposal.”

In a post-FTT world, the total of the notional amounts traded by the buyside are multiplied by the proposed EU tax rate of either 0.01% for corporates or 0.02% for fund manager examples (transactions between financial institutions and dealers are taxed at 0.01% on both sides of the trade). The resulting FTT payable on the trades is calculated as an absolute amount and then displayed as a percentage increase over and above the transaction costs that the client experienced pre-FTT.

Corporates typically use FX products to hedge their exposures as they export and import goods and raw materials. By imposing an FTT, these European corporates will see their FX transaction costs rise by up to 700%. For example, with just a single dealer, a business based in the tax zone could see its annual FX transaction costs rise from €1.8 million to €15.7 million per year. The tax creates a disincentive for international trade, investment and growth. The tax creates a disincentive for international trade, investment and growth, said GFMA.

A pension fund manager investing globally has multiple cash flows in different currencies on various pension portfolios. The fund manager needs to be able to convert all these currency flows into a single balance on a weekly basis, undertaking FX transactions to meet liabilities in different currencies. For a pension fund manager, the FTT impact is compounded due to the double sided nature of the proposed tax and these users could see transaction costs rise by around 1,500 % and possibly by as much as 4,700%, said GFMA. A pension fund manager used to annual transaction tax costs (via a single dealer) of €1.2 million, could see transaction costs caused by the FTT exceed €57.6 million. These costs will be passed onto investors in the form of poorer investment returns, it added.

Commenting on the impact assessment of the proposed transaction tax, James Kemp, managing director of the Global Financial Markets Association’s Global FX Division said: “The FX market is highly transparent, highly liquid and underpins international commerce and investment by providing corporates and fund managers with an efficient way of carrying out their business.

“Given the need for Europe to kick-start economic growth, it is crucial to ensure that European companies of all sizes are able to compete internationally. FX products are central to their ability to do this. In addition, the proposed tax risks becoming a disincentive for businesses to hedge risk which could increase their earnings volatility and business risk.

“The effect of the proposed tax on pension funds is even worse than on corporates, as it will be taxed on both sides. The result will be reduced fund performance to the detriment of institutional and individual investors.”