The Institute of International Finance fired a salvo across the bows of Europe’s controversial financial transaction tax (FTT or Tobin tax) with the publication of a highly critical position paper in late April. The Washington-based financial institutions trade body warns of the “considerable harm” the tax would inflict on institutional investors and financial markets as well as the real economy, sovereign debtors, private investors and financial stability were it implemented in its current form. It says the tax would ultimately “prove ineffective” and have “far-reaching implications” for European and global financial markets.
Eleven European Union member states – Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain – are set to implement the tax in January 2014. The proposal is for a minimum flat-rate tax of 0.1% on the gross market value of cash transactions with these countries’ financial institutions. It will be imposed on stocks, bonds, repos and securities lending with trades anywhere in the world linked to securities from these countries.
Market participants are particularly concerned about the potential impact of the tax on the repo market. Indeed, the International Capital Markets Association (Icma) warns that the tax would force the short-term repo market in Europe to contract by at least 66%. “One of the major challenges here is simply that nobody involved in designing the financial transaction tax really understands the repo market and how critical it is,” claims Richard Comotto, senior visiting fellow at the Icma Centre, Henley Business School, University of Reading.
On April 16 a working party from the 11 participating states formulated a set of questions for the Commission on the proposals as they stand. They were particularly concerned about the impact on the repo market, saying: “The extinction of the market will negatively affect the sovereign bond market and by consequence will raise government bond funding costs. Repo operations are very useful for managing the treasury liquidity and the disappearance of this market combined with the lack of viable alternatives will induce serious problems about risk management.”
They also raised the point that a 0.1% uniform tax rate might create an inappropriate burden on short-term bonds and repo operations compared to long-term bonds. “This suggests sensitivity (at least in places) to the impact on money markets and short-term funding costs that we haven’t seen previously,” says Hans Lorenzen, credit strategist at Citi, who warns, however, that any resultant lower rate on short-dated instruments might be offset by higher tax levels on less desirable instruments such as OTC derivatives for now subject to a proposed 0.01% tax.
Icma is calling for secured financing, which includes repos and securities lending, to be exempted from the tax. It is also calling for the exemption of primary dealers and market-makers or brokers in fixed-income securities markets. FTT treatment of various parts of the fixed income market is crucial to the viability of the tax itself as these instruments will provide the lion’s share of projected revenue.
The Commission calculates that a narrower regime focused on equities would raise just 0.06% of the GDP of participating states (€4 billion to €5 billion) as opposed to the €30 billion to €35 billion it reckons it can raise from the current proposals, or 0.4% of their GDP. “The inclusion of repo would have limited economic benefit, yet would close one of the main arteries of the financial system,” says Lorenzen. “Our expectation is that some of the most far-reaching elements of the proposal are likely to be eliminated or watered down and the timeline for implementation will slip well into 2014 if not 2015.”