The European Union’s (EU) Financial Transaction Tax (FTT), which 11 member states voted to introduce back in January has drawn criticism in two new studies from the International Capital Market Association (ICMA), which is concerned about the impact on the repo market and lending to businesses, and from interdealer broker ICAP, which is worried about driving business away from the EU.
The first ICMA report, somewhat long-windedly called ‘Collateral damage: the impact of the Financial Transaction Tax (FTT) on the European repo market and its consequences for the financial markets and the real economy’ was commissioned by the European Repo Council at ICMA. It claims that if introduced next year by the EU11 the FTT would cause the short-term repo market in Europe to contract by at least two-thirds, with serious negative consequences for other financial markets and the real economy. The Netherlands is still deciding whether to join the EU11 adopting the FTT, while certain countries such as France have already introduced their own national schemes. Opposing countries such as the UK and the Nordics are adamant they will not adopt the measure, restricting its implementation to the core EU members of Germany and France, and their southern European allies, but they are subject to EU ‘federal’ law so may well have to collect the tax anyway, which will fall disproportionally on London as global trading hub.
Authored by Richard Comotto, senior visiting fellow at the ICMA Centre at the Henley Business School, University of Reading, UK, the ICMA report argues that it is essential for secured financing, such as repo and securities lending, to be exempted from the FTT to ensure an efficient debt capital market and to support continued collateralisation of the financial markets.
Comotto stresses that the repo market is crucial to the efficient functioning of almost all financial markets; providing cost-effective and secure funding for professional financial intermediaries, which in turn lowers the cost of financial services to investors, commercial paper issuers, non-bank lenders and others.
A major contraction in the repo market of the EU11 adopting the FTT would have several adverse effects, adds Comotto. The loss of repo and the lack of an alternative secured financing instrument would pose serious problems for institutional and corporate investors, who would be forced into unsecured deposits which are not subject to FTT.
Lending by banks to industry would also be compromised because banks are unable to readily borrow from institutional investors and manage their liquidity in the interbank market. The absence of an efficient repo market to underpin primary and secondary debt market activities would make it harder for financial institutions (FIs) and firms in the real economy to raise adequate capital from banks, but especially for non-bank investors.
Corporations are increasingly filling the gap left by banks since the 2008 crash and ICMA is worried that this might be adversely impacted by the FTT. The difficulty of raising working and investment capital would impose a competitive disadvantage on the EU11, corporates and governments, believes ICMA. An earlier survey by the ICMA European Repo Council (ERC) showed the total value of outstanding European repo contracts, under which banks pledge securities as collateral in return from funding from money market managers and other investors, is declining. The latest figures show that on 12 December 2012 it stood at €5.611 trillion; indicating a 9.5% reduction in business since December 2011 when the figure was €6.2trn.
EU monetary policy would also be challenged by the disappearance of EU11 repo markets as repo provides the framework of collateralised transactions through which the European Central Bank (ECB) monetary policy is transmitted. Funding from the ECB has been crucial in staving off the eurozone crisis and keeping European financial markets, institutions and countries solvent.
ICAP Takes Aim at FTT
A second study, from interdealer broker ICAP, also attacks the FTT. It lists various negative effects of the trading tax that it claims would result from its implementation across the EU11. They include:
- A negative effect on the real economies of the FTT zone.
- A significant increase in funding costs for government and corporates, particularly those in the EU11 adopting the FTT.
- Contravention of EU treaty freedoms.
- Increased systemic risk.
- A negative impact for the UK government financially, despite the UK being one of the largest generators of FTT revenue because of London’s central position as a trading hub.
- The resulting migration of markets from the EU, rather than a net global reduction.
ICAP cites an estimate by Bank of America Merrill Lynch (BofA Merrill) that the FTT will result in an increased annual interest cost of €6.5bn to €8.5bn for Germany, Italy and France in its first year alone.
“The proposed FTT is a misguided policy which would be severely detrimental to both EU economies and businesses,” said Michael Spencer, group chief executive officer (CEO) of ICAP. “According to our research, if implemented, it would severely damage the functioning of debt markets which are essential for governments and companies to raise finance. It would increase both their borrowing and operational costs and lead to a flood of financial activity being moved outside the FTT zone.
“It is particularly ironic that London, as one of world’s leading financial centres, will generate the lion’s share of this revenue and act as collection agent despite the UK being outside the FTT zone and our government being vehemently opposed to the introduction of this tax. The impact on the City if the FTT is adopted in anything like the manner advocated would be devastating.”
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