implementation of a harmonised financial
transaction tax (FTT) in the EU that would aply to a wide range of financial transactions.225
Although the EC failed to implement the tax at the EU-wide level, 11 member states226 (or the “EU-11”) were given the approval to go ahead without other EU members227. The 2013 proposal for a Directive228 specified the following:
A minimum tax rate of 0.1% will be levied on the consideration (or in some cases, market value) of non-derivative transactions,
224 Hökmark, Gunnar (2015) “Amendments 300-608 on the
proposal for a regulation of the European Parliament and of the Council on structural measures improving the resilience of EU credit institutions”, report to the European Parliament Committee on Economic and Monetary Affairs.
225 EC (2011).
226 These member states are Belgium, Germany, Estonia, Greece,
Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia.
227 The EU-11 were granted permission to do so on 22nd January
2013 under the EU’s enhanced cooperation procedure (EC 2013a).
including shares, bonds and sovereign debt securities; and
A minimum rate of 0.01% on the notional value of derivative transactions applicable to most trading in equity, sovereign debt, corporate debt, repurchase agreements (repo) and derivatives.
The tax is applicable even if only one of the financial institutions resides in a member state of the EU-11 FTT. In addition, it also covers trades between entities outside the EU-11 FTT member states in instruments issued in the participating member states. The proposed FTT will be applied to both the buy and the sell side, creating a ‘cascade’ effect that will result an increase in the effective tax rate. Some transactions and parties are exempted: CCPs and Central Securities Depositories (CDSs), primary market transactions (including underwriting), transactions with international bodies or institutions
that form part of a restructuring are also exempt from FTT.
France and Italy have gone ahead with implementing the their own financial transaction tax regimes. The French regime was introduced on 1 August 2012, and applies a tax on equity purchases of listed French companies with a market capitalisation in excess of €1 billion, a tax on the purchase of uncovered CDS on EU sovereign debt and a tax on cancelled or modified orders to capture HFT activity. The Italian regime is similar to the French one but has a wider scope, e.g. it includes contracts for difference used for hedging.229Initial studies have shown the significant negative effects on market liquidity as a result of recently-implemented financial transaction taxes.230
Figure 5.1 shows the transmission mechanism of FTT, and how these taxes translate into impacts on market makers, market liquidity and end-users.
Figure 5.1: Transmission mechanism of FTT
Source: PwC analysis
The implementation of the FTT would increase the costs of trade execution across asset classes, which, in turn, affects the commercial viability of market making activities. The following effects may be observed in different asset classes:
Corporate debt markets: The tax would increase costs, and as we have observed reduce trading volumes. The secondary market effect will ultimately translate into higher costs of funding in primary debt capital markets for non-financial corporates. London Economics (2013) estimates the cost of funding for non- financial corporates to increase by 44-212 bps,
229 A contract for difference consists of an agreement (contract) to
exchange the difference in value of a particular currency, commodity share or index between the time at which a contract is opened and the time at which it is closed.
230 Becchetti, Ferrari and Trenta (2013) show that the French FTT
has had a significant negative impact on trading volumes. Haferkorn and Zimmermann (2013) show that trading volumes
with the cost for non-participating member states being potentially higher than for the EU-11. Oliver Wyman (2013) estimates the additional annual financing cost to corporates to be in the order of €7-€8 billion across the EU. The proposed FTT would also have extraterritorial impacts outside the EU-11.231 In Sweden, a relatively small tax of between 0.002 percent and 0.015 percent was applied to transactions of fixed income securities and their derivatives. This triggered a substantive behavioural reaction: the volume of bonds and futures trading fell by between 80 percent and 98 percent (PwC, 2013).
for French equities dropped significantly following the introduction of the tax, accompanied by an increase in spreads and a decline in top order book depth which increased transaction costs for market participants.
Derivatives markets: The FTT will have a significant impact on the derivatives market. The EC estimates that the tax would reduce trading volumes by around 70%-90%.232 The increase in transaction costs as a result of reduced liquidity could also be significant: Oliver Wyman (2013) estimates that bid-ask spreads under the FTT regime could be 18 times higher even under normal market conditions. The proposals aim to reduce socially undesirable trades but could risk making socially useful trades uneconomical, which will affect the ability of investors and corporates to manage their exposures to the price risk of commodities, currencies, interest rates, and equities.233 The lack of exemptions for hedging purposes also means that treasury services such as hedging could be vulnerable to greater volatility.234 Given the anticipated detrimental impact on volumes the tax revenue generated will potentially be limited. Money market funds235: Investors would
experience lower returns on their investment as a result of the FTT. EFAMA (2011)
estimates that money market funds would contribute around 67% of total tax revenues, if the expected reduction in volumes are not taken into account. Goldman Sachs (2013) expects an effective tax of 100 bps to be levied on typical money market funds, which would ultimately be borne by investors236. The increase in cost and decline in returns may incentivise investors to switch to products outside the scope of FTT, which reduces demand and liquidity inside the FTT area. Equity markets: The evidence of other
financial transaction tax regimes are mixed for the equity markets: while some studies suggest that the French tax regime reduced market volatility (e.g., Becchetti et al., 2013)237, other theoretical models have found that such tax increases volatility (e.g. Habermeier and Kirilenko, 2003).238 Analysis by Credit Suisse (2014) also shows that the implementation of the financial transaction tax regime in Italy has resulted in a reduction in average daily turnover in Italian equities of almost 30% between January and March 2013.
232 EC (2013), Schulmeister (2011) also found the impacts on
transaction volumes to be of a similar magnitude.
233 International Regulatory Strategy Group (2010). 234 Oxera (2011).
235 Favoured by investors who want safe and stable rates of return,
money market funds are investment funds that consist of a portfolio of short-term securities, which aims to maintain a steady net asset value.
236 McConnell (1995) and Malkiel and Sauter (2009).
In summary, these three areas of regulatory reform, if implemented in their current form would continue to put downward pressure on market liquidity. These reforms are likely to have extra-territorial impacts beyond Europe and the US. Although the majority of recently-proposed or implemented reforms originate in Europe and the US, regulators in other parts of the world may follow suit with similar reforms, which will directly affect market participants based in other regions.