EU officials appear to have softened their approach to collecting a tax on financial transactions by 11 European governments that signed up to the agreement.
It was reported this week that the tax on equities would be reduced from 0.1% to 0.01% and the introduction of the tax for fixed income and derivatives might be staggered. The EU proposed tax is due to take effect in January. An official told Reuters that the first phase might only apply to equities, with bonds and derivatives to follow in a staggered process.
The Financial Transactions Tax’s detractors have grown in volume since the initial proposal last year. The EU officials said the tax would correct the mistakes of the financial services industry by taxing financial institutions for their role in the crisis, and hand the €31 billion a year, to be collected by the tax, back to the tax payer. However, reports this week suggest the tax would raise less than €3.5 billion.
Sources are concerned about the impact it will have on the repo market, with a recent study commissioned by the European Repo Council of the International Capital Market Association said the Financial Transaction Tax (FTT) saying it would cause the short-term repo market in Europe to contract by about 66%. 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 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.
Commenting further, Godfried De Vidts, chair of ICMA’s European Repo Council and Richard Comotto, senior visiting fellow, ICMA Centre, University of Reading, say the proposed decrease on the tax does not address the underlying devil in detail of the tax and would still make repo trades uneconomical. “A tax on a nominal trade of €1 million for one day is a flat rate of 10 basis points and would be applicable to each counterparty,” says De Vidts. “Each pays €1000, leading to an overall cost of €2000 at 5bps. A market-maker would pay €1,000 on both sides leading to an overall cost of Eu2000. A 1 million over night trade at a 5 basis point bid-offer spread makes the market-maker €1.39. The trade is simply uneconomic -unless the market-maker can recoup his cost by charging 75% for the cash he on-lends! If the FTT is now 0.01% the market-maker still has to pay €200 in tax but is still only earning €1.39. Nothing has really changed.
“The whole FTT concept being discussed is not credible and it needs revision. There is a possibility that repo might be exempted but the tax would still be applicable on bond trading. The EC expect investors to buy direct from the primary market but they need the ability to buy when they want and to sell. This means they need secondary markets and dealers. Although the authorities are also pushing for a true capital market in Europe, there will be no capital market without a bond market and no bond market without the repo market.”
Comotto identified concerns with the proposals to replace the repo market with pledges: “If you pledge collateral, you retain a property interest. In repo, you transfer all title. So you default on me, I can simply sell the collateral you sold me through repo but you can delay or derail my resort to the collateral you pledged. That will pose more risk to lenders and increase the cost of funding. Although pledging is used in the US repo market, it is a second best solution adopted because title transfer is difficult. In Europe and the rest of the world, collateralize trades through repo makes cross-border trading straightforward. Because the US uses pledging, it is essentially a domestic market. Why is anyone proposing that we regress to a second-best legal framework for collateral?”
David Lewis, EMEA head of SunGard Astec Analytics any reduction in a tax burden, whether future or present, is to be welcomed “when that tax has been described by some as similar to throwing sand into an engine. However, even a little sand can do harm if the engine is already in a fragile state. It should also be noted that many observers are indicating that the basis of the tax is wrong in its objectives and implementation – changing the quantum of the tax will not change its fundamental flaws.”
A spokesperson for the European Commission said: “It is far too early in discussions on the FTT proposal to start guessing what the eventual compromise between the 11 Member States will be. Discussions are still taking place at technical level, and good progress is being made. The 11 member states have shown that they are still fully committed to the harmonized approach to the FTT,” said the spokesperson.
“Obviously, with such a complex and sensitive proposal, the technical work takes time and there are many different ideas, views and suggestions on how to reach a compromise amongst the 11 Member States. The 11 member states specifically requested the Commission’s proposal as the starting point for their negotiations. They will, on this basis, now need to agree on a compromise that is acceptable to all 11 of them.”
Scaled-back FTT Still Uneconomical for Repo Market, Say Industry Experts
Experts say the proposed decrease on the tax does not address the underlying devil in detail of the tax and would still make repo trades uneconomical.