The change would mark a notable reversal of the proposal, which in its current form relates to all secondary market share, debt and derivatives transactions executed in 11 of the 28 European Union member countries.
It might also lessen the negative impact on the real economy, and corporate sector in particular, as one of the main unintended consequences of the EC’s FTT was to substantially raise companies’ cost of wholesale funding.
“The original form of the proposal would affect the costs of normal commercial hedging for end-users, including corporates, and while primary issuance would be exempt, FTT on secondary transactions would affect the pricing of both debt issues and new equity issues,” says Sarah Lane, partner at accountancy firm KPMG.
However, expectations are growing that some “compromise” might be in the offing, given schisms within the group of 11 EU member states that favour the tax, as France and Germany want to move ahead before European parliamentary elections in May.
“An FTT confined to equities would be much more acceptable, and might be supported by states not currently participating in the enhanced cooperation process – but it would reduce projected revenues,” says Lane.
She adds it might also lead to markets seeking to use derivatives to synthesize equity exposure to escape the tax.
The FTT is estimated to generate up to around €35 billion per annum, but a tax on equities alone would reduce the proceeds to around €5 billion.
“It would be better for financial institutions if the tax is watered down to shares, although this will still not resolve many of the problems with it,” says Tom Cartwright, partner at law firm Pinsent Masons.
“If the tax does relate to just shares it will have a narrower impact, but may not be sufficiently targeted at risky transactions, which is supposed to be the genesis of the proposed tax in the first place.”
Michelle Price, associate policy and technical director at the Association of Corporate Treasurers, says they do have “serious concerns over the impact that the FTT, as currently drafted, would have on non-financial corporate”.
“Not only will the cost of hedges increase but the liquidity in some markets may reduce to an extent that some funding and derivatives may no longer be available,” she says. “If the FTT was watered down to just share transactions, this would be a significant game change.
“However the impact on non-financial corporates should not be underestimated.”
An Oliver Wyman report in September commissioned by the Association for Financial Markets in Europe estimated an annual increase in costs of between €8 billion to €10 billion for companies alone under the proposal as financing and risk management become more expensive.
This represents 4% to 5% of post-tax corporate profits and has a material impact on the ability of corporates to invest or pay dividends to shareholders.
Between €7 billion to €8 billion of this increased cost relates to a higher cost of financing through the debt and equity capital markets, as investors require higher returns to compensate for the increased transactional costs.
This reflects a 10 to 20 basis point increase in the yield on future corporate debt issuance, and a 6% to 8% reduction in market capitalization on future equity issuance, the Oliver Wyman report states.
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| Giles Williams, partner at KPMG |
“Non-financial companies, which are critical to the European economy, need to hedge their financial exposures,” says Giles Williams, partner at KPMG. “The original FTT proposals would increase their cost base and this is not desirable when the eurozone economic position is fragile.” Companies expect increased financing costs to drive reduced investment in infrastructure projects, as marginal investments turn negative. Oliver Wyman says capital-intensive sectors, such as utilities and manufacturing, could be hit hard.
“Any large company which uses commodities – whether agricultural, metal or hydrocarbon – will want the option to manage price and foreign-exchange volatility using derivatives,” says Williams.
“If the underlying costs of such products are increased by an FTT, the company will have a stark choice – either post lower profits or pass the costs on to the consumer. In a fragile economy, with intense global competition, this could have real economic consequences.”
The FTT has been highly contentious among EU member states. Of the 28 member states, only 11 – Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovenia, Slovakia and Spain – are moving forward with the proposal, while other members such as the UK, Sweden, Denmark and the Czech Republic oppose it.
However, the FTT could also increase the cost of funding for companies in the EU outside the group of 11. London Economics predicts corporate issuers in non-participating member states might experience increases in their funding costs that could push the effective tax rate up to 1% rather than the 0.1% tax envisaged.
The FTT was originally due to be implemented by January 1, but the proposal is unlikely to be implemented until 2015 at the earliest, since an amended agreement has yet to be drawn up, market participants say.
“It seems likely that attempts to push through revised proposals before the end of the current EU parliament in May will be unsuccessful, given the full agenda and time pressures,” says KPMG’s Lane.
“Depending on the appetite of the new Commission and parliament, this may well lead to a revised proposal in late 2014, with possible implementation of a watered-down form of EU FTT in 2016.”
However, while a watered down FTT is a better option than a tax on bonds and derivatives as well, not everyone is convinced the change will be for the better.
“Some say an FTT on equities will have no impact on the real economy,” says KPMG’s Williams. “However, with a longer-living population, the long-term performance of the stock market is critical to the performance of pensions and long-term savings.
“Even a small FTT charge, because it impacts the whole transaction chain, taken cumulatively over a long period will have an adverse impact on yield and value.”