In a presentation to analysts last month, FXCM CEO Drew Niv pointed out that the planned Financial Transaction Tax (FTT) is slated to be a disrupter for European financial firms. The proposed FTT is to be introduced during 2014 and would impose a 0.01% to 0.1% tax on Equity, Bond, and Derivative transactions. Exempted assets are spot FX and physical commodity trading. Currently, the tax is being supported by 11 EU countries as a means to increase public revenues while simultaneously reducing risk taking. Opposing the FTT is the UK, whose government and financial firms believe that they will be adversely effected by the tax even as a non-participating country. The concern is due to the taxation that will occur between cross border transactions, where UK market participants will incur costs related to the collection of the tax, but received funds will only be dispersed to participating countries.
Following on these concerns UK interdealer ICAP has published a report that warns of the negative impact of the planned FTT (read the entire report).
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Headlines from their analysis:
- “FTT will damage the mainstream economies of those countries in The FTT will damage the mainstream economies of those countries in the FTT zone to the relative benefit of those markets and the FTT zone to the relative benefit of those markets and economies outside the zone. We anticipate that the more pronounced effect will be migration of markets rather than net global reduction. “ They expanded on this by explaining that FTT zone companies will be expected to create outside subsidiaries for the purpose of trading and issuing of bank debt to circumvent the tax.
- FTT zone banks and dealers will become less competitive due to the tax effecting their pricing. The explained that FTT zone banks or corporates would find better pricing from non FTT counterparties “who could price most competitively by accessing the non-FTT zone wholesale FTT zone wholesale market for hedging. In due course one would expect to see this pressure weigh heavily on FTT-zone banks who would be structurally less competitive and FTT-zone corporates and other customers of the market would migrate their business to banks outside the FTT-zone.”
- This in turn would lead FTT zone firms to become takeover targets. “As the cost of equity will will be structurally significantly higher in the FTT-zone, companies outside it will find a natural pricing arbitrage when considering, say, a takeover e.g. target stock is priced down (reflecting reduced yield due to FTT); predator stock can price that out; and a tax synergy helps foreign takeovers make sense.
- UK Effect Positive. ICAP stated that they estimate that “30% of OTC derivatives that are currently traded through London involve an FTT-zone counterparty on at least one leg of the transaction.” This could lead to FTT zone firms opening UK subsidiaries to circumvent the tax on trades involving UK counterparties.
- UK Negative. ICAP stated “The UK will generate the largest FTT revenue but its contribution to the EU budget will not be reduced.” They explained that “ in the case of a transaction involving a counterparty erparty based in France and a counterparty based in Germany based in France and a counterparty based in Germany, the revenue raised would be shared equally between France and Germany. However, in the case of a transaction involving a counterparty based in France and a counterparty based in the UK, all FTT revenue would go to the French tax authorities. The UK-based counterparty would also incur costs relating to collection and payment of that revenue. “ They added that spread are expected to widen as primary dealers may exit the market and “A significant proportion of wholesale market trading in UK gilts involves FTT-zone counterparties (some GEMMS would appear to be captured by the Residence Principle). If secondary market trading in public debt remains within scope, UK borrowing costs would likely increase because the FTT would insert itself between the bid and offer, thereby widening spreads.”
- ICAP also questioned the method of collection. Without a central system to account for the tax and its collection, the burden will fall on financial firms. “This would require significant systems change and investment, even for firms whose Governments would in no way benefit from the revenues that were raised.” Due to the expenses and new policies needed to collect and monitor the FTT, the report added “The systems change that would be required means operationally it will not be possible for many firms to be compliant by the intended implementation date of 1 January 2014.”