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09 January 2014

EU FTT: Populism, or Common Sense?

Recent efforts to derail the EU financial transaction tax are likely only to delay its introduction. But the delay might be the only remaining opportunity for firms and regulators to examine and prepare for the operational impact of the tax.

In December, German banking associations sent letters to the European Commission asking to outlaw the financial transaction taxes imposed by France and Italy. It was widely reported that six leading German financial industry groups had lodged the complaint with the European Commission – calling the tax “a breach of European law.” The groups are headed by all the relevant business associations of the German financial sector, including the savings and cooperative banks and the investment fund industry. They also include the Federal Association of Public Banks, which represents state-owned promotional banks and the regional Landesbanken.

Many see this as a bid to stop the more “pernicious” EU-wide version of the FTT. But keep in mind that the EU directive on capital taxes cited by the business groups doesn’t refer to trade in securities; rather, it refers to the raising of capital in the primary market. Also consider that the German government has already rejected a previous complaint from these same bodies about the French tax in 2012.

[Related: “Making Sure the European FTT Stays Finished”]

Notwithstanding the UK’s legal challenge of April 2013 or the EU Council legal service’s opinion of September 2013, it may be more a case of stalling than stopping this juggernaut. A “stall” seems a more plausible outcome given two important developments since September 9:

  1. The outcome of the German elections of 22ndSept 2013, in which Chancellor Angela Merkel’s conservative CDU party failed to secure an absolute majority of seats and entered into a coalition government with the socialist SPD party, has opened the doors for this tax. Indeed, the two partners pledged in their coalition treaty to “swiftly implement” a broad tax covering “shares, bonds, investment certificates, currency transactions and derivative contracts.”
  2. Popular momentum – that guiding beacon of legislative policy – is making it increasingly difficult for politicians of all hues to oppose this tax. According to Sven Giegold, finance policy spokesman of the German Green Party in the European Parliament, “The German taxpayer funded the second-most-expensive bank bailout in Europe, and the state is having a lot of trouble getting its money back.” Or, as in the words of Pascal Canfin, the French deputy minister for development, “With the European tax, we can solve the problem of additional financing for the fight against climate change.” He additionally warned that there would be no global deal on climate change at the 2015 UN summit in Paris without new sources of financing.

EU finance ministers weren’t expected to discuss the tax when they met in Brussels on Dec. 10, as they focus instead on finalizing a plan to centralize control of failing euro-zone banks—the next step in the banking union project. However, and from informed sources, there is every indication of reaching a political agreement on this tax before May 2014 and the European Parliament elections. That, just about, gives market participants time to assess the impact and craft a compliance strategy.

As operational taxes go, the EU FTT encompasses a breadth and depth far surpassing any before it. And there are serious costs on being caught operationally short – monetary and reputational! From a macro/market structure perspective, a significant shift in asset class appetite is expected, with some trading strategies (read: HFT) rendered uneconomical. Inter- and intra-firm risk management practices will require re-thinking, as firms change legal entity structures/domiciles to reduce their tax exposure – necessitating a re-modelling of changes in counterparty exposures. With the forecast reduction in specific asset class liquidity and inclusion of specific instruments within the tax ambit, direct costs of hedging risk also begin to add up.

[Related: “HFT Arms Race Is a Problem, But a Tax Isn’t the Solution”]

Speaking of costs … a same-day-payment tax applied on residence and issuance (need we add economic substance test?) principles implies a level of complexity that even Tier 1 firms will possibly struggle to process digitally from day one. As STP rates fall, throwing more bodies at the problem begins to yield diminishing returns. And as the example of the French and Italian versions bears out, cost per trade begins to climb!

Since non-compliance is not an option and operational readiness is near impossible from a standing start, this “reprieve” till May might just be the window of opportunity. Most firms have completed, to varying degrees of diligence, an economic impact assessment. What needs follow is an operational impact assessment covering the systems, processes and data affected. What rules will need to be written – where – to enable real-time, in-line processing of the tax as transactions are executed by the second? Are there any COTS solutions worth investigating for a potential buy-vs.-build consideration? The more prescient (prudent, perhaps?) among us would have snuck in a “change budget” for 2014 – now would be a good time to revisit and validate.

There remains a full body of work underway at institutions for other regulatory programs (FATCA, DFA, MiFID II, LEI, RRP, etc). Now would be a good time to investigate cross-overs and synergies for avoiding costly duplication and, potentially, conflict. Unlike any other operational tax, the EU FTT will require a whole new set of complex connections between participants of the financial eco-system – agents, brokers, industry utilities, infrastructure providers, regulators, etc. Needless to say, new file formats, data exchanges and communication protocols will need to be built, tested and deployed.

A broad, though unspoken, consensus emerged among market participants post the Italian FTT. The inevitability of (some form of) this tax, coupled with the operational complexity and ongoing cost pressures, implies a strategic approach to solving this problem. The experience of developing CREST in the UK is instructive for the effort required in evolving an industry utility – and market participants will need an interim, though synchronized, individual effort. How will that work and who will play what role is a useful discussion for industry bodies to intermediate.

In the ensuing months, any effort expended to size this problem will be well invested in terms of guiding the lobbying effort. It will present opportunities for the fleet footed as order flow routes to more economical venues, and for different products designed for a new “preferred habitat.” It would, then, appear rather commonsensical to re-invigorate the lobbying effort with inputs from a focused analysis of operational impact.

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3 Comments to "EU FTT: Populism, or Common Sense?":
  • Comment_headshot

    10 January 2014

    This is such an interesting topic! You raise a lot of good points.  (Thinking out loud)...I am curious what evidence regulators have that this will work, especially when it has never worked (never) when implemented.  And especially as markets become more connected across the globe and become more electronic, why wouldn't these financial transactions just simply move out of the EU to a country that doesn't tax? 

  • Missing

    10 January 2014

    You are quite correct in that all evidence, and experience, points in the opposite direction to success. But how will the Commission measure success - tax revenues raised, or particular types of trading/market participants banished. The latter is also a stated intention - but with, as you rightly identify, unpleasant, unintended, consequences.

    I feel the strong popular & political momentum may prove a very strong current to oppose. Even if the EU plans were to be, lets assume, abandoned, will it mean the repeal of existing taxes in the UK, France and Italy (to name a few)? Are there many comparable markets with zero transaction taxes that can accept this re-routed flow? If so, are they ready?

  • Missing

    01 February 2014

    Interesting statement put out by the 46th French-German Economic and Financial Council - "that France and Germany will make joint proposals to reach a compromise on a common scheme of taxation for financial transactions, within the next months, with all our partners from the enhanced cooperation."

    Very noble intent ... but, as usual, very little detail to help any planning!

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