Financial markets, to borrow from the film The Big Lebowski, could be about to enter a world of pain. That is, if the past is any guide to the future and if plans for a broad-based European financial transaction tax (FTT) continue to make headway. Industry figures say the tax, as mooted, could push bid-offer spreads in many markets much wider, siphon off liquidity and drive up volatility for a range of assets or instruments. In a twist of irony, the levy could end up punishing, rather than helping, a number of shaky sovereign bond markets with potentially disastrous results for the global financial system.
The process for agreeing the tax is somewhat opaque and fraught with uncertainties due to a complex political backdrop and a cacophony of views. So the uncertainties are large and numerous. But while there are plenty of questions about the scope, scale and timing of the tax, there does seems to be little doubt that the political will is there and many industry figures believe that some kind of a cross-border FTT will emerge, albeit one that is potentially not as draconian as what is currently being discussed.
How worried are the members of the International Swaps and Derivatives Association?
Richard Metcalfe, deputy regional director and senior regulatory advisor for the association, summed it up in one word:
Richard Metcalfe, International Swaps and Derivatives Association
An FTT for the whole European Union is out of the question, with countries such as Britain and Sweden firmly against the idea. But under a procedure known as "enhanced cooperation", the tax can be agreed for some EU countries as long as at least nine sign up. The euro itself was created through enhanced cooperation.
Mention the FTT, however, and the word "cooperation" is not the first thing that springs to mind for many in the market.
"Contrary to what some of the proponents of the tax are saying, the FTT clearly hits investors," said Keith Lawson, senior counsel for the Investment Company Institute, which represents US buy side companies. "Any FTT that's paid by a mutual fund is paid by its shareholders through a lower return."
But before delving into the implications of the tax, it helps to understand the background and the basics of what falls in the scope of the current proposal.
In September 2011, the European Commission issued an initial proposal for a wide-ranging FTT, having explored the idea of how to make the financial sector bear more of the cost for the fallout of the 2008 global financial crisis. Then, in October of last year, the Commission proposed that enhanced cooperation be allowed for an FTT. This had the backing of 11 countries and was supported by the European Parliament. Those countries, representing more than 90% of the euro zone economy, were: Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain.
Finally, in February of this year, the Commission put forward a plan for the so-called EU-11. The tax would be for 10 basis points of the nominal amount transacted. It would be both issuance-based and residence-based. Issuance-based meant it would apply to any security issued in one of the participating countries, regardless of where the trading took place. Residence-based meant it would apply to any transaction that involved a firm deemed to be in the EU-11. It would cover equities, fixed income and derivatives.
Meanwhile, while all of this had been going on, two prominent EU countries - France and Italy - had already been implementing their own national FTTs. The idea was that these would be replaced by the EU-11 version once it was introduced.
Then, in late May, signs emerged that the Commission was scaling back its ambitions. This was hailed by market participants as a victory for common sense. Brussels had been besieged by industry representatives who sought to show the harm that could come from a tax of that size and scale. The Commission, it emerged in a Reuters report, was said to be looking at a much smaller tax of one basis point, one that initially would only apply to stocks and only later (if at all) to fixed income and derivatives.
Algirdas Šemeta, the European Commissioner for Taxation and Customs Union, who has been spearheading efforts to enact the tax. Soon after the Reuters report, Šemeta was quoted as saying it was premature to say what the final outcome would be, although he has since suggested the Commission could consider lower rates for some market segments.
Stealing from the rich?
These taxes are often called Tobin taxes, named after Nobel laureate James Tobin who proposed the idea of taxing financial transactions. They're also known as Robin Hood taxes, and the idea of taxing the rich to help the poor has generated massive popular support in many European countries in the wake of the global financial crisis.