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Securities and Fund Services
European Financial Transaction Tax
What it means for investors and financial markets
Europe’s proposed financial transaction tax (FTT) has been widely analysed within the
financial community, though its implications are less widely understood among investors,
corporates and consumers. We look at what the impact may be, what the final proposal
may look like and how clients can prepare.
Where we’ve come from ...
The FTT was first proposed by European Commission
president Jose Barroso in September 2011. The European
Parliament voted in favour in May 2012 despite strong
opposition from a number of member states. The proposal
was then passed to ECOFIN, the European Council body
responsible for deciding tax matters.
In October 2012, after a lack of unanimity in ECOFIN,
11 countries agreed to proceed with the FTT under the
‘enhanced cooperation’ procedure, which is open to
a minimum of nine member states. The 11 are Austria,
Belgium, Estonia, France, Germany, Greece, Italy, Portugal,
Slovenia, Slovakia and Spain (FTT Zone). The Commission
subsequently issued substantive proposals in February
2013 that are being negotiated and eventually implemented
by the 11. Although the European Parliament’s role in the
enhanced cooperation procedure is minimal, it supported
the proposal, with suggested amendments, in July this year.
Separately, France and Italy have both introduced an FTT
on equities. These taxes came into effect on August 1, 2012
in France and on March 1, 2013 in Italy. On September 1, Italy
extended the tax to equity derivatives.
...and where we are now
The situation remains fluid. In April 2013, the British
government filed a legal challenge to the decision
authorising the use of enhanced cooperation with the
European Court of Justice. In June, the Commission
tacitly admitted that the January 2014 launch date was
no longer realistic but the FTT could still enter into force
towards the middle of 2014. Tax commissioner Algirdas
Semeta subsequently said the Commission was prepared
to consider lower tax rates in certain market segments –
including government bonds and pension funds1.
Impact on the markets
The European Commission expects the FTT to reduce
trading in derivatives by 75% and in cash equities and
bonds by 15%2. This is supported by trends in French and
Italian equity turnover since the two countries introduced
their own FTTs. According to Tabb Group, France’s share of
European equity market volume has fell from 21% before
the introduction of the FTT to 12% in July 2013, while
Italian equity turnover halved3. Citi’s Hans Lorenzen, Head
of European Investment Grade Credit Product Strategy,
says the proposed tax has big implications for liquidity.
2
The impact is likely to be ‘particularly pronounced in fixed
income, reflecting higher transaction costs relative to likely
volatility.’4 Short duration products are expected to be most
affected. Bank of America Merrill Lynch argues that ‘the
FTT as currently constructed would render a whole range of
current financial products and practices uneconomic.’5
Prime among them is repo, a €1tr market. Mr Lorenzen
says: ‘The proposals would have an enormous impact on
repo markets, where overnight rolling costs would amount
to no less than 22% annually. In all probability, all repos
would have to be re-documented as some form of loan
transaction, which is not straightforward as it creates a host
of other problems associated with the transfer of ultimate
ownership.’ The International Capital Markets Association
has warned that the Commission’s proposals put the
‘economic viability of the industry at risk.’6
There are concerns, too, about the securities lending
market. According to the International Securities Lending
Association, this generated incremental revenues of €3bn
for long-term investors in Europe in the year to May 2013.
ISLA predicts that applying the FTT as envisaged would
reduce the market to about a third of its current size.
‘Securities lending fee levels would need to increase by over
400% just to maintain current revenue streams,’ it says7.
Operational and infrastructure issues
The FTT has wide operational implications. ISLA suggests
the tax could result in the removal of close on €500bn of
government bonds from the lending/collateral markets.
‘The growing demand to borrow high quality collateral for
the purposes of collateralising centrally cleared and other
derivative transactions will be substantially undermined
by the FTT with pools of potentially eligible collateral
effectively left immobilised by the tax’, it says8.
Entities other than those party to the transactions (such
as CCPs / CSDs / ICSDs, and by default their members)
under Article 10 of the proposal could be held jointly and
severally liable for collection of the FTT. Clearing members
have a principal relationship with a CCP and as such
central clearing will also incur an FTT charge. At present,
they and a CCP only take counterparty risk on each other.
However, the introduction of joint and several liability for
the payment of the tax on all participants in a transaction
chain – as envisaged in the Commission proposal – could
introduce anonymous counterparty risk.
Costs to market participants
Goldman Sachs has estimated the impact on Europe’s
top 42 banks, on a 2012 pro forma basis, at €170bn –
assuming no move to mitigate the tax by, for instance,
exiting affected businesses. The FTT would also reduce
the profitability of Europe’s exchanges and inter-dealer
brokers, it suggests, by around a fifth on average.
Derivatives exchanges would be more severely affected9.
The consultancy Oliver Wyman says: ‘Non-bank financial
institutions such as pension funds, insurers and asset
managers are hit as they bear a direct tax levy as well
as any portion passed through by the dealer, potentially
doubling the tax burden for these users.’ 10
Under the Commission proposal, asset managers will
incur the FTT at two levels – on transactions undertaken
at the portfolio level and in the trading of fund units.
Goldman estimates that Europe’s fund managers could
find themselves contributing around €17bn a year in FTT:
‘Our top down analysis implies that investors based in FTT
countries could face an annual tax of 17-23bps on their
equity and bond portfolios’. 11
Wider implications
The proposed FTT has implications at the government,
corporate and individual level.
The Commission expects the economic impact to be
either slightly negative or slightly positive, depending
on how the tax revenues are used. The original impact
assessment suggested a very significant impact on GDP 12.
One uncertainty is the extent to which the FTT will increase
government bond yields. Mr Lorenzen has pointed to a
number of factors – the cost of ‘cascading’, wider bid-offer
spreads and a probable decline in the number of primary
dealers – that would not only lead investors to demand
higher yields but oblige sovereign issuers to syndicate their
issuance, at a higher cost. ‘This likelihood is reflected in
the comparatively outspoken comments against the FTT
made by several national debt management agencies,’
he says.13 Another impact may be the disappearance of
some contracts or products altogether, not an increase in
spreads, if the effect is too great.
The Commission expects trading in government debt to
raise €6.5bn in tax annually. This would more than offset an
estimated €2bn increase in debt funding costs. By contrast,
Bank of America Merrill Lynch puts the added funding cost
for just Germany, Italy and France at a minimum of €6.5bn
in the first year14.
Higher debt costs are also predicted for corporate issuers.
Business Europe, an umbrella organisation representing
industry associations across Europe, claims ‘the tax will
raise the cost of financing for firms and hence undermine
investment.’ It also warns that by making essential risk
management activities more difficult, it will damage
European companies’ competitiveness15.
End-investors will most likely bear a lot of the added cost,
says Oliver Wyman: ‘Prior studies have shown that as
3
much as 90% of the additional tax burden on financial
institutions is generally passed on to end-users.’ 16
Where next?
There are signs – both from the Council Working Group and
the European Parliament (which only has a consultative
role) – that some of the difficulties are now recognised.
Among the Parliament’s suggested amendments in
July were a reduced rate (0.01%) on repos and lower,
transitional rates on government bonds (0.05%) and
transactions involving pension funds (0.05% for equities
and 0.005% for derivatives). They also suggested a limited
exemption for market makers. These amendments appear
to chime with the remarks of Commissioner Semeta,
mentioned above, and recent calls for a scaling back of
the proposal from Pierre Moscovici, the French finance
minister 17. Reuters has reported that some countries
want all fixed income exempted, leaving a tax that would
primarily impact equities and derivatives18.
Another key compromise may be a focus on either the
issuance or the residence principle, but not to require
both. This debate is causing division amongst the EU11.
The European Commission and/or Member States may
undertake further impact assessment on this aspect.
Some reduction in scope therefore looks likely. Widely
reported debate19 between the 11 over the final shape of
the tax makes it highly probable the start date will be
formally postponed. The final decision to go forward rests
with the EU11 and requires their unanimous agreement
to do so, that is, all must agree on the final text. It is
also worth noting there is currently no method in place
for the collection of the tax and systems would need
to be reconfigured to identify the ‘establishment’ of
counterparties.
Just to sew further confusion, in an opinion dated September
6, 2013, the EU Council legal service advised EU finance
ministers that the Article 4 (1) of the proposal ‘deemed
establishment’ principal is illegal because it ‘exceeds
members states’ jurisdiction for taxation under the norms of
international customary law’. The opinion also maintains it
would not be compatible with EU treaties ‘as it infringes upon
the competences of non-participating member states’ 20.
How can financial institutions prepare?
Clients should plan on the basis that some variant of the
Commission’s proposal will take effect. It is widely thought
the German election in September will be an important
determinant to the course of the current proposal and if the
current coalition remains there is expected to be a narrower
FTT. Institutions need to monitor developments in Brussels
and assess the potential impact of the tax on their operations.
Outline of the Commission’s proposals
Outline of the Commission’s proposals
The proposal is intended to capture the vast
majority of financial instruments and financial
transactions, including all securities (equity and
debt), all derivatives, repos, stock lending, all
types of fund units, money market instruments,
structured products, swaps and possibly collateral.
Key exclusions are loans, spot FX transactions, spot
commodities, new issues and transactions with the
European Central Bank.
The FTT is payable by financial institutions. However
the definition of ‘financial institution’ is broad
and includes investment firms, credit institutions,
insurers, regulated markets, SPVs, UCITS/AIF funds
and their managers, retail investment funds and
pension funds. It is also likely to include the treasury
entities set up by many corporate.
The proposed FTT would apply to all transactions
globally where at least one party is a financial
institution ‘established’ in one of the FTT Zone
countries. ‘Establishment’ is widely defined (and
does not follow usual tax residence rules). The
‘establishment’ of that financial institution would
deem the same ‘establishment’ on a non FTT Zone
counterparty which is itself a financial institution,
making both parties liable for tax.
To deter relocation of business, the FTT will also
apply to transactions by financial institutions
‘established’ outside the FTT zone if:• F
TT Zone instrument – the instrument is issued
within the FTT zone, regardless of where their
counterparties are established and
• F
TT Zone counterparty – the instrument
is issued outside the FTT zone but their
counterparty is “established” in the FTT Zone
While the headline rates – of 0.1% on securities and
0.01% on derivatives – sound less than threatening,
the effective rates will be much higher. Because
the tax will be applied at every leg of a transaction,
where a financial institution is party, with only
CCPs, CSDs and ICSDs exempt, the tax will be
multiplied many times over. This has been called
the ‘cascade effect’. For a transaction involving
executing brokers and a clearing member on both
sides, the tax paid could be multiplied eight-fold.
What is clear is that the impact of the FTT will be widely felt.
Firms need to assess the fall-out on two levels. First, what
is the impact on each business line? There may be some
areas of trading or investment where the very viability of
an operation is called into question. Second, what is the
impact on the business model as a whole? Does FTT require
a change in strategy, a shift of resources, investment in new
businesses, activities or geographies?
While the final shape of the FTT remains uncertain, that
planning needs sooner rather than later.
Questions our clients asked us:
Q:Would all collateral substitutions in a repo be
subject to FTT?
A:This has not been dealt with clearly to date. But any
change of ownership or material modification, such
as moving assets internally within a corporation or
modifying a derivative, are caught in the scope of the tax.
Q:Would the London branch of an FTT zone bank
dealing in non-EU securities be liable for FTT?
A:Yes, though if it were a subsidiary it could possibly be
exempt (but only if its customer is not ‘established’ in
the FTT Zone). Changing from one to the other may be
viewed as an anti-avoidance measure.
Q:What is your best bet for the final outcome?
A: Repo and government bonds will most likely be
exempted, while the lending of equity securities is
taxed. Given the disagreements between member
states, it is possible that FTT starts with a narrow
scope and more markets – such as securities lending
– are brought in later. It is possible that an FTT on
an issuance basis only is considered a more readily
achievable objective, although such a compromise does
not appear to have been reached as yet.
Speech to European Parliament, Jul 2, 2013
European Commission Staff Working Document Impact Assessment, February 2, 2013
3 Tabb Group European Equities Market: 2013 Mid-Year review, September 3, 2013
4 Citi Research, April 10, 2013
5 Financial Transaction Tax – toll or roadblock? Bank of America Merrill Lynch, March 25, 2013
6 International Capital Markets Association press release, March 11, 2013
7 International Securities Lending Association, Impact of the Financial Transaction Tax on Europe’s Securities Lending Market, June 3, 2013
8 Ibid
9 Goldman Sachs Equity Research, Europe: Financial Services, Financial Transfer Tax: How severe?, May 1, 2013
10 Proposed European Commission Financial Transaction Tax Impact Analysis on Foreign Exchange Markets, Oliver Wyman, January 2012
11 Goldman Sachs Equity Research, Europe: Financial Services, Financial Transfer Tax: How severe?, May 1, 2013
12 European Commission Executive Summary of the Impact Assessment, September 28, 2011
13 Citi Research, April 10, 2013
14 Financial Transaction Tax – toll or roadblock? Bank of America Merrill Lynch, March 25, 2013
15 Letter from Business Europe Director General, Markus J Beyrer, May 6, 2013
16 Proposed European Commission Financial Transaction Tax Impact Analysis on Foreign Exchange Markets, Oliver Wyman, January 2012
17 Reuters report, July 11, 2013
18 Reuters report, May 30, 2013
19 Ibid
20Reuters report, September 10, 2013
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