FTT brings derivatives market to tipping point

FTT brings derivatives market to tipping point

Leading figures in the European derivatives industry have issued stark warnings this week about the detrimental impact the proposed Financial Transaction Tax (FTT) may have on the market, writes Jonathan Watkins.

The European Parliament has estimated a potential €20bn could be generated from its levy on derivatives, while a finalised FTT plan from the European Commission has brought the controversial toll to the brink of implementation.

Under plans approved by Brussels last week, the 11 participating countries now able impose a 0.01% levy on derivatives trading.

Speaking to FOWi, Anthony Belchambers, CEO of the Futures and Options Association, said the introduction of an additional charge is set to land the end user with further costs, and could be detrimental to market liquidity.

Loading the industry with further costs

“It is an appalling time to consider loading up the industry with yet further cost,” said Belchambers.

“Increases in direct costs and pass through costs are cumulative and will have to be met by the end user and the question for the end user is how and from whom will the end user recover that significant increase in cost?”

“There is a tipping point which could generate a decline in order flow which, in turn, could damage liquidity and the risk management transfer process – and one of the lessons of the recent crisis was the need to enhance the risk management capability of intermediaries and end users rather than reduce it.”

Despite facing a lower tax percentage than shares and bonds, derivatives transactions are still set to make up for two-thirds of the estimated €30 to €35bn expected to be generated from the FTT each year.

Another attack on the economics of trading

Commonly referred to as the Tobin Tax, the levy has become a contentious issue among EU countries, both for and against, along with heavy opposition gathered on the other side of the Atlantic.

Calling the tax a bullet aimed at the heart of London, the UK has strongly opposed the tax from the outset and has been joined by Washington, Wall Street and leading European exchanges.

“This is just another attack on the economics of trading in the marketplace and the industry just doesn’t need this with all the major increase in regulatory and compliance spend which is being faced by the firms at the moment,” said Belchambers.

“Are we going too far with all of this and not really thinking sufficiently about the consequences for the economics of market participation.

European backlash

"It is interesting that David Wright, secretary general of IOSCO, only recently commented that more thought should be going into the economic consequences of regulatory change agenda.”

Germany is one of the 11 countries set to introduce the tax and is estimated to generate €10bn alone.

But Deutsche Börse group, parent company of Eurex, has also warned of the potential unintended consequences of implementing such a charge.

“EU regulators want transparency and stability for the financial markets, which is justified, and they also want financial firms to pay part of the cost,” said Deutsche Börse’s CEO, Reto Francioni.

Sparking furious responses on both sides of the Atlantic

“But the tax will make sure that financial services transactions move to less regulated markets and those who did not cause the crisis will be burdened.”

 Participating EU countries

· Belgium

· Germany

· Estonia

· Greece

· Spain

· France

· Italy

· Austria

· Portugal

· Slovenia

· Slovakia

The exchange operator also warned that the tax may counter the G20 efforts to foster the regulated and transparent markets.

“The impacts of this potential tax show a striking discrepancy between political objectives derived from the financial crisis,” said Deutsche Börse.

“By introducing the tax in only 11 member states of the European Union theses negative impacts will only play out more strongly.”

Novel and unilateral theories

Despite being a fractional charge only implemented in Europe, the FTT has also sparked extreme opposition from a coalition of US businesses.

The group, which includes the US Chamber of Commerce and the Financial Services Forum, has written to the European Commission objecting the unilateral imposition of a global financial transaction tax

“These novel and unilateral theories of tax jurisdiction are both unprecedented and inconsistent with existing norms of international tax law and long-standing treaty commitments,” said the group.

Concerns have also been raised in the US that the FTT could be in breach of international laws.

Complexity and uncertainty

While some believe the tax may cause a migration of business, the reality could be that the complexity and uncertainty could cause a drop in trading altogether.

If market participant re-calibrate their needs and start managing their risk less or using more standardised instruments, derivatives volumes could be set for yet another hit.

"If you do over-tax trading in one area, it moves," said Justin Urquhart-Stewart, director of Seven Investment Management.

This was demonstrated by France’s early roll-out of the tax, which initially failed to target the majority of larger derivative traders by leaving open a loopholes in which trades using derivatives instruments could dodge the charge.

Higher tax on HFT

The Italian government could be next in line to implement the levy which will also include a 0.02% charge on high-frequency trading (HFT).

Italy’s FTT could be introduced as early as March 2013.

Algirdas Semeta, the EU tax commissioner who has frequently championed the FTT, described it as an unquestionably fair and technically sound tax set to strengthen the market.

"With today's proposal, everything is in place to enable a common financial transaction tax to be become a reality in the EU,” he added.

“Eleven member states called for this proposal, so that they can proceed with the FTT through enhanced cooperation.

“I now call on those same member states to push ahead with ambition – to drive, decide and deliver on the world's first regional FTT."

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