By Jonathan Watkins.

The legal challenge facing the controversial European Financial Transaction Tax may not herald the end of efforts to implement it, a leading market commentator has warned.

Europe’s highly-contested FTT suffered a major setback this week after the EU’s top legal advisor concluded it is discriminatory to non-participating countries.

But despite the strong challenge to the tax, which includes a 0.01% levy on derivative transactions, Christian Voigt, business solutions architect at Fidessa says that the tax may still be implemented.

“The legal opinion highlights some fundamental flaws in the definition of the scope of the EU FTT,” said Voigt.

“I think at the very least, the current EU FTT draft requires considerable modifications.

“This is a key opportunity for the legislator to go back to the drawing board, address the issues highlighted by the opinion and come up with another proposal.

“If the legislator chooses to push ahead they could re-work the current proposal and go forward with that.”

Not legally binding

The conclusions from the EU Legal Council are not legally binding but deal a heavy blow to the European Commission’s proposal which has been much debated in the financial markets.

The idea of taxing equities, derivatives and high frequency trading was estimated by the commission to generate around €35bn annually.

The 0.01% charge on derivatives transaction alone is predicted to bring in around €20bn.

However, many industry experts believe the levy will reduce liquidity in the market and have spoken out against the tax from the outset.

FTT on FOWi: Italy first out the blocks to tax HFT The FTT pill: hard to swallow? Italy delays FTT on derivatives UK may oppose FTT with legal challenge FTT brings derivatives market to tipping point

The issue of who the tax would apply to in transactions where one counterparty was a resident in a participating country and the other wasn’t also spurred further arguments.

The legal council has now concluded that the tax is “discriminatory and likely to lead to distortion of competition to the detriment of non participating member states" for this reason.

A watered-down version?

It also stated the FTT exceeds member states' jurisdiction for taxation under the norms of international customary law.

“It’s a very strong legal opinion and even though it’s not legally binding, I can’t see how the legislator could ignore it,” added Voigt.

“The opinion includes criticism that has previously been voiced by the industry, and confirms that the proposal is flawed in its current state.

“In a way, this has brought sanity back into the EU FTT discussion, because the legal service of the Council of the European Union confirmed a lot of the industry concerns.”

Germany voices support

Voigt added that a watered-down version of the tax is now more likely to be considered by the European Commission.

EU tax commissioner Algirdas Semeta has been at the centre of rolling out the FTT, commonly referred to as the Tobin Tax, and was quick to defend it despite the legal challenge.

Tobin’s tax What would Nobel Laureate James Tobin have thought of his name being attached to one of the most controversial tax proposals in modern times? While it is true that he was the author of a transaction tax in 1972, his proposals were far removed from what is being proposed in his name four decades on. The “Tobin Tax” was originally conceived in the post-Bretton Woods world of international currency instability. His tax, which he again advocated in the wake of the Asian financial crisis of the late 1990s, was intended to solve the problem of short term speculation in global currency markets. Tobin identified that a fundamental challenge of free floating currencies was that they fell prey to speculation and short term flows of investment. To dissuade such short-term speculation, Tobin proposed a small tax on each conversion of one currency into another. Such a tax would, in his famous phrase, “throw sand in the wheels” of the machine of international capital flow. Today, his name is used by people who seek rather to throw sand in the eyes of the speculators. Tobin’s tax was designed to reduce volatility in the currency markets and deter speculation in times of market stress, not as a panacea applied to tax all trades in almost any asset class. Shortly before his death in 2002, Tobin bemoaned the fact that anti-globalisation activists had “hijacked my name” in their calls for a transaction tax and what is being proposed today is greater in scope and potential impact than anything that has gone before. .

“FTT is legally sound and fully complies with EU Treaties and international tax laws,” Semeta wrote in a tweeted message.

Semeta has championed the tax from the beginning, claiming it will strengthen the market.

He has urged the eleven participating countries – which include France, Italy and Germany – to push forward with implementing the tax.

Legal concerns must be dispelled

Germany’s finance ministry also voiced its continuing support for the FTT despite the latest setback.

"The German government advocates a swift introduction of the FTT for good reasons. We want to make the financial sector contribute adequately to the costs of the financial crisis," the German finance ministry said in a statement.

"Nothing has changed on that.

“The legal concerns must be cleared up and dispelled as quickly as possible."

Despite those pioneering the tax adamant the levy will still be put into place, the legal opinion will undoubtedly make it harder to move forward with the FTT in its current form.

“The bottom line is that they have to re-work the scope of the EU FTT – I would say the best thing is to re-design the scope from scratch because of the fundamental criticism,” said Voigt

“If they go forward, I expect a more sensible and realistic proposal.”