Exhibit 1: European Equity Turnover 2012
Source: Thomson Reuters/ TABB Group
The addition of the Italian Financial Transaction Tax will have a far greater effect on overall European volumes in 2013. While only accounting for a 6% of European market share, the cumulative effect of the combined two tax regimes, plus the extensive reach of the Italian regulation, will cripple model-driven strategies, stunting the recent return of higher volumes. Add in a worsening economic environment and the addition of a further nine countries looking to implement the financial transaction tax by January 2014, and the prognosis for European equity trading looks bleak indeed.
No One Is Safe
The original objective to regulate HFT activity and make markets more transparent and fair for all is in danger of restricting all automated flow for all market participants – across the globe. The shift of focus in the legislation to cover both the “residence” principle and the” issuance” principle would in effect mean that no one is beyond the reach of European regulators. Meanwhile, the legislation is so complex and contradictory that for many, it will be easier simply to cease trading rather than establish what tax is due when and on which venue.
The irony is that HFT was already on the wane in Europe. Due to a combination of reduced volatility and increased correlation between stocks, there has been limited opportunity to arbitrage. As a result, HFT strategies were diversifying their flow – and given the lack of alternative liquidity, there were those on the buy side that were willing to engage with it.
By including all automated flow in the new regulations, however, the ability of market participants to interact will be severely impaired. Without natural orders to ease the flow of liquidity, we risk returning to volatile markets, which will further deter investors and create the very conditions that would make HFT profitable once more.
[Related: “The Fool and the Financial Transaction Tax”]
At a recent SunGard “Meet the Regulators” event last month in London, it became apparent that European regulation is at risk of unraveling due to its level of complexity. Regulators disagree among themselves what is required, and where; politicians are manipulating policy; and the financial markets are at risk of grinding to a halt under the weight of complexity. As countries become impatient with the lack of progress in Brussels, independent legislation is emerging that serves only to add to the confusion.
The Death of the Dark in Italy
The rules out of Italy are still in the proposal stage, but so far the draft outline for March 1 looks like this:
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A tax will be liable regardless of the place of residence and where the contract is concluded, and is applicable for firms with a market capitalization of EU 500 million or more.
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The initial tax of 0.12% in 2013 will reduce to 0.1% in 2014, but will incur an additional increase to 0.22% for 2013 (to 0.2% for 2014) if trades are executed OTC.
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There is an additional tax of 0.02% on high-frequency trading, which will be applicable if the ratio between canceled and modified orders exceeds 60% and if the order is canceled or modified within half a second -- added to which, the tax is only applicable to the number of securities exceeding the threshold multiplied by the average price on the netted transactions – easy!
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Derivatives will be taxed on a sliding scale, depending on instrument and notional value of the transaction. You could be charged anything from 1.5bps on index derivatives to 10bps on single stock – and so confusion reigns.
Dire Consequences
Brokers’ internal dark pools will be the first hit, as there is no mention as yet of the new organized trading facility (OTF) category, which looks to have been given a reprieve under MiFID II. Clients will ask brokers to turn off their routing systems to avoid higher fees in internal dark pools for Italian stocks, and it will become more difficult and expensive to trade blocks. Algorithms will have to be throttled back, and electronic trading will become less efficient as a result. Only a decreasing number of Italian stocks will have sufficient liquidity to trade on the lit exchange without incurring market impact. And if model-driven trading is driven out of the market, a significant chunk of liquidity will disappear, and we will revert to wider spreads and increased volatility.
Of course, the elections this weekend will provide an answer to whether the Italian tax gets shelved or not. We could all come to work on Monday and discover Berlusconi is back. But this would not be the end of European regulation. The MiFID II compromise is now expected this summer, with a final vote in the Autumn. Given there is now contention between the regulators, the European Commission and the Council, it is up for debate what will finally be delivered.
There is a real danger that in the interim, European politicians will make European capital markets irrelevant. Market participants will not be willing to – or will not be able to – support the added cost burden and investors will simply head to Asia.
The issue of liquidity and transparency in European equities will be discussed at the EMEA Trading Conference organized by FIX Protocol next Thursday in London. Please come and join the debate.
Comments | Post a Comment
20 Comments to "FTT Migraines in Milan Could Cripple European Equities ":
ltabb
22 February 2013
For those that think that the FTT doesn't impact people in the US. Think again.
Anyone trading anything with European (currently French and Italian - but soon to be more) exposure will get hit no matter if its an Ordinary, an ADR, a fund, or an ETF. Currently the tax is being taken out at the custodial or sub-custodial level and brokers are getting invoices from their custodians.
So unless the transaction requires no location movement (one account to another account within the same broker), the registrar, or the custodian will be sending the broker an invoice. Now if you are buying into a fund - the fund gets the invoice. An ADR or ETF the guy who creates or destroys the ADR/ETF, or something where you need a hedge in an underlying - the hedge will be taxed and the broker will get the invoice. Currently a lot of US brokers are getting invoices from their custodians without any way of allocating this tax back to the client.
This will eventually cause market makers and brokers to widen spreads, and or increase commissions. From the folks I have talked with its a real mess with some firms getting invoices for more than 100k a month which they right now have to eat. What a mess.
Comments (303)
Anonymous
25 February 2013
"The original objective to regulate HFT activity and make markets more transparent and fair for all "
Which why it would be interesting to see a separate graph of the HFT volumes: it could show that the volume slide in equity trading mostly concerned virtual (aka fake) volume/liquidity hence pointing out to saner, more solid european equity markets.
rhealey2
25 February 2013
Thanks Larry - this is situation currently for firms having to work around the French financial tax. The situation regarding the Italian FTT would appear more alarming in that participants are still unclear what tax they will be paying when. Article 6 refers to the tax will being determined "on the net balance .. equal to the average of the weighted rates across the RM or MTF". It would appear impossible to establish in advance the best venue to trade if you do not know the tax you will be charged until after the event. Added to which this is all supposed to be in place by Friday. The mind boggles.
Comments (89)
rhealey2
25 February 2013
Thank you Anonymous - the issue is that HFT activity in Europe would appear to be decline given recent news stories. The FTT would appear not be targeting just HFT activity but all automated activity - given their proportion of activity in the market currently - irradicating this portion of activity will have a dire effect on overall volumes.
Comments (89)
ltabb
25 February 2013
I guess the real question is that Anon was getting at - ok so volumes decline, but if those volumes are just one hft selling to another hft or hfts getting in the middle of investors longer horizon trades, then who cares, besides exchanges. If the real investor volume stays constant and only hft volumes shrink - then isn't it a net win, even if the volume is 20% or whatever lower?
That said, any tax or increase in trading costs should reduce the number of trading opportunities and reduce volumes. I guess the question is by how much? And will that shift volumes to another location, force issuers to issue outside of Italy or France or the FTT zone, or just fall harder on smaller brokers who can least afford to eat these taxes if they can't be passed back easily to investors?
Comments (303)
Anonymous
25 February 2013
That was my point indeed, thanks Larry. On the other hand I'm not sure why you're saying any increase in costs should reduce volumes, in general as well as in this particular case. Small fluctuations in VAT for instance are known to produce small to no effect on sales. I doubt traders are piloting their activity and with an eye on 1/10 000 cost increases on a part of their global volume. or that investors start thinking twice because of that for that matter - I'm not even sure they notice.
Anonymous
25 February 2013
Current economic limbo Europe is in is probably much more impacting equity volumes than anything else btw.
ltabb
25 February 2013
Economically speaking - if you raise the price of something demand will be reduced. But how much so depends upon the trading strategies. Certainly anyone with any sort of time horizon (weeks+) shouldn't be impacted by a small tax, however market makers, liquidity providers, and certain short term alpha hedge funds may be impacted.
That said and this is probably what Rebecca is getting at - if you reduce the competition to be top of book (by taxing market makers, liquidity providers, and short term alpha players), then spreads will widen and investors will pay more to get in and out. Which should have a magnifying aspect to the tax. But we will only know this by looking at what happens after the fact.
you could say that we could judge this by looking at london, but the UK stamp has a lot of loopholes so it really isn't a good analogy.
Comments (303)
lberke
25 February 2013
12 bps, 10 bps, 22 bps, an extra 2bps, 1.5 bps - pretty soon you're talking real $$. If I'm an international fund manager and my benchmark includes the affected markets, my investors can add that transaction tax to my management fee and now you're REALLY talking real money. Quite the handicap when it comes to attracting investor flows by delivering positive relative after-tax performance. As a bit of an investor myself, I think I will avoid the whole mess and invest elsewhere.
Comments (129)
Anonymous
25 February 2013
If we're to speak economics, effects of price increases depend on the product (price elasticity etc) as well as the way price increase is sold to the clients. And if we're speaking real dollars then we should also speak real markets: on HFT-pumped-up volumes even a small FTT could cost a lot - that's exactly one of the rationale behind the tax. OTOH the version adopted in France also has quite a lot of loopholes, as far as I'm aware.
rhealey2
25 February 2013
Thank you for your comments. The bigger issue in Europe is the change in regulatory focus – this is no longer about targeting HFT – the French FTT is on end of day netted positions, something which HFT is able to sidestep. The growing complexity and reach of the FTT rules is going to hurt the very market participants the regulators purport to protect. This utopian idea that markets will be okay so long as we only have true orders in the market is pure fiction. You need client facilitation and this is continually coming under increasing stress in Europe. Either the brokers re-engage in capital provision and risk pricing – an activity that is becoming available to just a chosen few (see the results in European Equity Trading 2012/13: Changing the Rules of Engagement) – or you require other market participants to plug the gap – hence the growth in European buy side choosing to interact with “HFT” flow – or at the very least being able to have the choice.
I agree that small fluctuations in VAT are unlikely to have small to no effect on sales – but usually taxation changes have enough advance notice and clear rules. UK stamp duty is clearly defined and understood. Italian FTT is mired in confusion and due on Friday – that is an entirely different state of affairs. Current economic limbois impacting equity volumes, you are correct but a confusing and contradictory tax certainly won’t improve matters.
To your point Laurie, this should now be a major concern in terms of losing international investors into Europe – that will be a data point to watch over the next six months – and one we will be watching closely.
Comments (89)
Anonymous
26 February 2013
I agree 100% true-orders markets are not necessarily a good thing, however I'm not sure markets made 50-60% of HFT are any better - or that is the point of some of the regulation : no one ever demanded 100% true order markets ; alas, it seems this kind of logical shift happens quite often in lobbying argumentation.
I also agree FTT propositions grew more and more complex. Much like everything around Basel 3, Solvency 2 and so forth - EU commission and national governments should have cut endless bargaining with the big banks far sooner and for the FTT use the thumb rule : a small rate on a very wide base. I suspect despite London being one of the freest financial places, the tightest, if not toughest regulation will come from there. Curiously enough everybody sounds pretty much content with that - at least publicly.
Anonymous
26 February 2013
I'm not sure why anybody assumes that you can tax the financial industry in those 11 countries to the tune of 35 bn euros and nobody would notice. This amounts to multiples of what is generated in securities businesses in those 11 countries and is more than the profits of all banks combined. At the same time all these banks need to raise capital to comply with CRD IV so they have nowhere near the ability to pay anything like this amount. I do not understand why its relevant to discuss HFT in relation to this FTT. Sure HFT will be impacted by lower volumes but the repercussions for the rest of the financial industry are very significant and much more relevant. Think for example about an active institutional asset manager in any of these 11 countries, they would also be charged a tax on any trade they did outside of these 11 countries. This manager could never compete with anybody outside of this FTT zone and would have to move or shut down. Or what about the bond markets? Because of CRD IV there will be a much greater reliance on European bond markets, but how can a corporate issue 3 month CP at 50 bps if the buyer and any subsequent seller and buyer has to pay 10bp tax. Or how is Eurex going to compete with the CME in its interest rates contracts if buyers and seller are charges 10 euros per contract extra. The commission itself calculated that a European FTT would cause a negative hit to GDP of almost 4%! Again, why is it relevant to talk about what will happen with HFT firms and activities in this context?
Anonymous
26 February 2013
http://www.nytimes.com/2013/02/22/business/a-tax-that-could-change-the-trading-game.html?ref=business&_r=1&
Just a few quotes:
"The tax would be tiny for investors who buy and hold, but could prove to be significant for traders who place millions of orders a day."
"The tax would be far smaller than the fixed commissions that American investors once took for granted, and even less than the costs implicit in the fact that until decimalization arrived in 2001, that most stocks could move only in increments of one-eighth of a dollar, or 12.5 cents. Markets, and the American economy, managed to prosper. "
"One objective, says Algirdas Semeta, the European Union commissioner in charge of tax policy, “is to reorient the financial system back to financing the real economy.” ""
ltabb
26 February 2013
The difference is, back when spreads were wider, it was the industry getting the money not the government. When the industry gets money, besides paying bonuses, they hopefully provide services, such as research, support, high touch desks, and analytics.
Under the tax plan, the government gets the money, volumes decline (cause the cost of trading goes up), but commissions don't go up (cause they never do), and the market becomes less and less serviced.
The folks that are most likely to get the short end of the stick are the smaller guys who have less scale than the larger guys to absorb it. Now everyone says we are overbroked but everyone wants research, support, tech, and services. And the industry continues to consolidate. Smaller guys are going bust, and the larger guys continue to consolidate high and low touch desks.
I just see this as a catalyst that will just accelerate this trend.
Comments (303)
Anonymous
26 February 2013
Ok, I think we agree that the annual Euro 35 billion tax bill will not be paid for by the financial industry and certainly not by HFT firms. It would certainly be discouraging trading if that's deemed to be a good thing so I think what we're saying is that there will be less liquidity. We can debate whether less liquidity is a good or a bad thing, although arguing for less liquidity is somewhat ridiculous (but that's my opinion). The issue that is completely clear to me is who is going to pay for this: the end users, through their pensions. There is simply no other way because the financial institutions have no way of coughing up this huge annual bill. In fact, the Dutch pension fund APG, one of the world's largest, has calculated that it would cost them 550 euros annually per pensioner. These are real numbers and pensioners are already suffering a huge tax in the form of low interest rates (which is a tax on savers to finance spenders). The most scandalous part of this all is that politicians are presenting it as a tax on the banking industry which any academic agrees to is simply not true.
ltabb
27 February 2013
Good article today on impact of ftt on ny times http://nyti.ms/XeZFYH
Comments (303)
Anonymous
27 February 2013
"Smaller guys are going bust, and the larger guys continue to consolidate high and low touch desks."
This is alas the case with each and every point of the new regulation - and even before: Basel 2 favoured big entities who could afford inhouse rating and risk calculation - I suspect soon we'll see even more financial whales swimming around - and bigger. Talk about too big to fail.
rhealey2
27 February 2013
Thank you for all the comments. Interesting comment on BNY Mellon's website (http://www.adrbnymellon.com/files/AL36905.pdf)
BNY Mellon Italian DR Programs are hereby notified that it is unclear whether DRs are in or out of scope for application of the Italian Financial Transaction Tax (IFTT) with respect to Issuances. Therefore, at the close of business in New York on February 28, 2013, BNY Mellon will close the books for the Issuance of the below listed DRs of Italian programs and will not accept deposits of shares into custody, pending further clarification of the IFTT application.
Comments (89)
rhealey2
27 February 2013
In relation to Anonymous' comments regarding the quotes - " the tax would be tiny for investors who buy and hold" and "far smaller than the fixed commissions" - the biggest concern for European instiutional buy side participants is the implict rather than the explict cost of trading. The French FTT has lef the industry relatively unscathed and workarounds have been found. It is the broader aspect of the IFTT and the cummulative effect on European liquidity that will impact - and that will hit performance of pension funds and therefore the man in the street. And then there is the real rub - "to reorient the financial system back to financing the real economy" - deluding voters with political soundbites only works if you are able to deliver.
Comments (89)