FTT: Far Too Tough?
Written by Trevor Morton
Trevor Morton looks at the controversy surrounding the Financial Transaction Tax
Set against a background of economic stagnation across the region as a whole and the perilous state of a number of EU member states, June 2011 saw the European Commission formally propose the creation of a Financial Transaction Tax (FTT). Modelled on the Tobin tax, its goals were to ensure that the financial services sector would, in the future, make a “fair and substantial contribution to public finances and for the benefit of citizens, enterprises and member states”. By October 2012, a club of 11 (EU-11) of the 27 members states had formed under the EU umbrella of ‘enhanced cooperation’ in the area of FTT. Brought forth with some alacrity (by EU standards), the proposed tax regime divides opinion both ways. By 19 April, the UK’s chancellor George Osborne, prompted by searing comments from the House of Lords EU Sub-Committee on Economic and Financial Affairs, launched a legal challenge against plans for the EU to tax transactions on shares, currencies and bonds where any party was based within the EU’s FTT zone.
Significant and growing disparities lie not only between the UK and the EU-11 on the impact and risk of FTT. In its February 2013 impact assessment statement, the European Commission claimed a limited impact on pensions. Few in the industry share this view. The Association for Financial Markets in Europe (AFME) argues that the European Commission underestimated the “severe” impact of the FTT on pension funds. AFME challenges many of the European Commission’s assumptions in a report compiled on its behalf by Oxera, a consultancy in economics and change. In the report, AFME warns that the tax’s drawbacks could accumulate ‘significantly’ over time. The commission assessed the impact of the tax on two illustrative pension funds – one passive and one active in terms of trading. “It finds a very small impact on the passive fund and a substantial impact on the active fund, reducing the final pension by nearly 8 per cent. For AFME, the commission’s outcome on the “rather limited impact” on passively managed schemes is due to “assumed mitigating actions”, such as reducing trading activities, not using repurchase (repo) activities and reducing derivative contracts. The association also rejected the commission’s assertion that pension funds stood to benefit from the reduction of activities by financial intermediaries through lower transaction costs.
So as the UK presses ahead with its legal challenge, what do noted industry specialists think of the FTT? According to ITG Director, General Counsel in EMEA, Juan Pablo Urrutia: “Over the last few weeks we have seen an uptick on press reports discussing the latest developments in the long and winding road to trying to agree the FTT amongst a select group of European Union member states. Those reports have now reached a crescendo pitch with announcements from none less than the governor Christian Noyer of the Central Bank of France that the European Commission’s plan for an European financial transaction tax will ‘bring nothing’ and that ‘[it] is not a tax confined to the banks. It would have repercussions on companies and individuals’. A little over a year ago, France was one of the key European governments that wrote to the European Commission asking for a speedy implementation of the FTT. So what has changed since then? The proposal that Noyer criticises is identical to the European Commission’s original proposal. More likely is that Noyer and others have now awoken from their policy-induced coma to the damage that the tax will create on pension pots of all Europeans as well as the European real economy.”
Source chief development officer Michael John Lytle notes: “The problem is that an FTT is an inefficient form of tax that is likely to fail to deliver on any of the objectives behind its levy: it seeks to punish the banks, but actually hits the savers and users of financial products such as exchange-traded funds (ETF). To start with, there is a primary fiscal problem. Countries pursuing the imposition of the FTT can charge a very small amount that has no real impact on behaviour. But it won’t add up to very much. If the EU wants to meet its stated target of €35 billion it will have to have a meaningful impact on the system wherever it takes it from. Imagine that you are a long-term saver using any financial product such as an ETF or are a pension fund investor saving for retirement over 30 years. During each of those years the EU collects €35 billion in revenues which sums to over €1 trillion, yet the current European asset management industry holds €7 trillion of assets. In that context €1 trillion of additional taxation will have a meaningful impact on retirement savings.”
Ultimately, there are two key elements to recognise about the FTT. One, it is likely to reduce economic activity by more than the tax gathered and two, the cost will not be borne by the banks as they simply pass on any costs to their customers who are the pension funds, asset managers and individual investors.
DLA Piper legal director Luigi Falivene highlighted the repercussions of FTT. “The FTT is threatening to fundamentally undermine economic recovery in the eurozone and has little upside in its current form. For the UK, though it will not be implementing the FTT, the tax poses a substantial threat to UK banks’ profitability as the tax will have a wide extra-territorial scope. It will impact any firm anywhere in the world that conducts trades in almost any form of financial product either on behalf of or with counterparts in an EU-11 jurisdiction or in shares or bonds issued by an EU-11 entity. In theory, a firm in the City should be no more exposed than a firm in New York or Singapore, but given the much greater proportion of the City’s business dealing with European securities the impact could be much greater here. One of the key drivers of the FTT is to disincentivise speculative or harmful trading activity. However there is by no means a consensus on whether the FTT will achieve this. Under its current design the UK is better out of the FTT than it is in it, the uncertainty around the tax’s implementation is only serving to cause more nervousness and uncertainty in the financial markets; fear and uncertainty are the last things the fragile eurozone, and global, economy needs at the moment. Events of recent days suggest it now looks likely that the FTT in its current form is set to be watered down considerably.”
Sharing his firm’s views with European Pensions, pensions industry specialist and consulting firm PwC director Roy Lonergan says: “The pensions industry is clearly disappointed that it is within the scope of FTT and it is important that it should continue to lobby for change. The Dutch government and others have raised this issue and in the past the European parliament had suggested that pension funds should be exempt. We can be sure that there will be significant changes to the draft directive as the process moves forward so the industry must continue to make itself heard in the debate. Individual pension schemes have not generally announced potential impacts, but the UK’s National Association of Pensions Funds has estimated that the total bill for European pension funds could be as much as €4 billion per year. The important thing for the industry to do now is to assess the impact of FTT. This will be a combination of understanding what instruments are held, who are the counterparties to trades and what is the rate of turnover in portfolios. That allows you to size up the issue and plan your response. With the uncertainty around scope and timing of the tax it’s too soon to do any more detailed work on implementation. There is a lot of uncertainty about the tax, both on scope and timing. That makes it difficult to plan with certainty but it seems clear that there is momentum behind the tax in the FTT-zone so the pensions industry must take it seriously and cannot afford to relax.”
However, there is a growing body of support for FTT from European pressure groups. In a recent letter to the Financial Times, the International Trade Union Confederation general secretary Sharan Burrow rounded on “double standards in the (financial services) industry” and cited “that the proposed tax is tiny in comparison compared to the charges for managing funds”. The FTT may yet come to pass, if only to save face. The best or worst outcome, depending on your viewpoint, may be a compromise.
Trevor Morton is a freelance journalist