The proposed EU Financial Transaction Tax (FTT) would cause the short-term repo market in Europe to contract by about 66%, according to a study commissioned by the European Repo Council of the International Capital Market Association.
This contraction would have serious negative consequences for other financial markets and the real economy, said the study.
The study, titled ‘Collateral damage: the impact of the Financial Transaction Tax on the European repo market and its consequences for the financial markets and the real economy’, was launched today at a press conference hosted by the European Banking Federation in Brussels. It argues that it is essential for secured financing, such as repo and securities lending, to be exempted from the FTT to ensure an efficient debt capital market and support the continued collateralization of the financial markets.
The European Union unveiled its proposal for an FTT to be implemented under an enhanced co-operation procedure by Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain. Together, these 11 EU countries are to introduce a new FTT, with the European Commission is setting out a common approach to collecting the tax.
The current FTT proposal is for a minimum flat rate tax of 0.1% on the gross market value of cash transactions with financial institutions located in the 11 EU member states, which have signed the enhanced cooperation regime. The flat rate is applied regardless of the length of term of the repo, making repo trading for terms of less than 12 months (and possibly longer) economically unviable. A major contraction in the repo market of the EU11 would have a number of unfortunate consequences.
The repo market is crucial to the efficient functioning of almost all financial markets; it provides cost effective and secure funding for professional financial intermediaries, which in turn lowers the cost of financial services to investors and issuers, says the study.
The absence of an efficient repo market to underpin primary and secondary debt market activities would make it harder for financial institutions and firms in the real economy to raise adequate capital from banks but especially for non bank investors, says the study. “The difficulty of raising working and investment capital would impose a competitive disadvantage on EU11 financial institutions, corporates and governments,” it adds.
The study claims EU monetary policy would also be challenged by the disappearance of EU11 repo markets as repo provides the framework of collateralized transactions through which ECB monetary policy is transmitted.
The global regulatory framework for ensuring financial stability, being put together under the Basel regime and requiring the collateralization of financial transactions would also be adversely affected. Collateral management would become too expensive and the infrastructure that supports the efficiency of collateral management would cease to be viable.
Godfried De Vidts, chair of ICMA’s European Repo Council said: “Harming the efficient operation of this market by the imposition of a financial transaction tax would jeopardize central bank monetary implementation and be at odds with the various steps taken by the ECB to safeguard the single currency”.
The ICMA study says the only realistic strategy is to spell out the implications of the current FTT proposal for public finances, monetary policy, financial stability and economic policy to those responsible for these policy areas, and seek to have the FTT recast as a purely fiscal instrument and not a tool for restructuring the financial market.
“As it is unlikely that the FTT will be abandoned or replaced by an alternative such as financial activity tax, realistic modifications need to be proposed that would avoid the extreme outcomes of the present proposal,” says the study. “These modifications should include: the exemption of secured financing transactions such as repo and securities lending from the FTT, and all movements of securities during the term of a transaction pursuant to the management of collateral (eg substitution), in order to support the collateralization of the financial market; and exemption from the FTT of primary dealers and market-makers in fixed-income securities markets, in order to preserve the efficient pricing and distribution of capital.”