Certain EU member countries want banks to foot the bill for plugging the budget deficit they helped to cause. But the resulting tax looks set to hit the real economy most of all.
What’s happening?
On February 14, 2013, the European Commission adopted a proposal for a Financial Transaction Tax (FTT) between 11 members of the EU – all of which are members of the eurozone. The initial intention is for the tax to come into effect on January 1, 2014. A tax rate of 0.1% will apply on all transactions of shares and bonds, units of collective investment funds, money market instruments, repurchase agreements and securities lending agreements, and 0.01% on all derivative products.
A European stamp duty?
No. The scope of FTT differs from the UK’s longstanding stamp duty on cash equity transactions, as well as from the national FTTs adopted in France and Italy in 2012. First, the extension to derivatives is a radical new departure. Second, there is no obvious exemption for market-makers unless they are deemed to be “acting on behalf of other financial institutions”.
“Most investment banks operate a broker-dealer model that involves taking on some principal risk in any transaction. There is a question now as to whether it would be better to adopt an agency brokerage model to gain exemption from FTT,” says Rod Roman, European banking and capital markets tax leader at Ernst & Young.
Time to relocate?
Banks based in the 11 FTT countries that operate trades through a branch outside may want to upgrade the branch to a full subsidiary, which would not be liable to pay the tax on all its transactions, says Mark Kingstone, a tax partner at law firm Linklaters in London. Even so, the tax has extra-territorial implications. Any trade involving an instrument with an FTT11 underlying asset – including derivatives – would be liable to pay the tax, even if both counterparties were outside the FTT11. Moreover, any client within the FTT11 will pay on their trades, even if they transact with a bank from outside the 11 countries.
Law of unintended consequences?
Naturally enough, banks will pass the costs along to their customers if they can. The European Parliament initially suggested exempting pension funds, but the European Commission appears to have ignored this exemption. An exemption would be of benefit to pension schemes, says James Walsh, senior EU policy advisor at the UK National Association of Pension Funds, but it would need to take account of pension funds' widespread use of external asset managers.
“On pooled equity investment funds, how would FTT apply if pension funds were exempted? Would the fund manager have to work out what proportion of their funds under management came from pension fund clients, and would the tax be deducted accordingly?” asks Mr Walsh.
The European Commission's published impact study estimated the total cost of the FTT on financial institutions at €34bn, and an earlier draft suggested this figure would be €30bn if pension funds were exempt.
That means Europe’s pensioners could be €4bn worse off if FTT is implemented in full without an exemption – hardly the intended target. Also affected would be corporates engaged in hedging foreign exchange risks on international trade or interest rate risks on their borrowings.
“The FTT is ultimately a tax on the real economy, on companies attempting to manage their risks responsibly. And there is a cascade effect: when a corporate engages in a hedging transaction, the bank will offset its own risk, so there is a series of transactions cumulating tax all the way. The end-user is likely to foot the bill, and the impact study does not seem to take this into account,” says Richard Raeburn, chairman of the European Association of Corporate Treasurers.
What do the banks say?
Even if they can pass on the costs, banks are concerned about the operational complications of FTT. The inclusion of overnight repos in the scope of FTT could cause a liquidity squeeze in this vital tool for liquidity management. The tax also appears to cut across the European Commission’s own drive for derivative transactions to be centrally cleared.
“If two banks transact, both will pay. And if both clear through a central counterparty, that is two more payments. The extra expense does not seem to be in tune with the regulators’ desire to encourage central clearing,” says Mr Kingstone.
Will it happen?
There is a general consensus the sheer scale of practical considerations the European Commission has not even started to examine will delay the launch date well beyond January 1, 2014. And the use of the EU Enhanced Cooperation Procedure that allows 11 countries to push on without the other 16 is on thin ice – it could be ruled illegal if any opponents of the tax can prove the FTT will distort competition within the EU. But with European policy-makers still haggling over the essential Capital Requirements Directive IV, there is a fear that its expeditious passage can only be bought by allowing more populist politicians to drive on with FTT.
