The variety of broker reactions to Italy's financial transaction tax (FTT), which levies a high rate on broker crossing networks, has led to buy-side confusion.
Brokers have responded in multiple ways to the levy, which levels a higher rate on trades executed in broker crossing networks (BCNs), compared to other types of markets. These include: passing the full tax to buy-side clients; shutting off BCNs for Italian stocks completely; absorbing the levy and letting the buy-side execute in BCNs at the lower rate applied to regulated markets and multilateral trading facilities; or executing off-market/on-exchange – a process where two parties to a trade agree a price in a BCN before executing that trade on a primary exchange.
The levy came into force on 1 March and taxes equity and bond transactions on exchanges and MTFs at 0.12%, and OTC trades at 0.22%. Under MiFID, BCNs are classed as a form of OTC trading. Derivatives are taxed on a sliding scale depending on instrument and size of trade.
Paul Squires, head of trading at AXA Investment Managers, told theTRADEnews.com that the off-market/on-exchange process hinged on brokers' interpretation of the language within the Italian FTT regulation.
"Some brokers are offering negotiated trades, where terms of a trade are set in a broker pool but are executed and reported on a recognised exchange. The term used for these trades is 'effected' and this lets brokers execute at a lower tax rate," Squires said.
A director of an investment bank, speaking anonymously to theTRADEnews.com, confirmed his firm was executing off-market/on-exchange for Italian equities and said this mechanism, although avoiding the higher levy, benefitted regulators and market participants alike.
"These trades are executed on exchange, which mitigates counterparty risk with central clearing and greater transparency to the market, while still allowing price formation to occur in the dark," he said, adding that Italy's FTT was out of step with recent European legislation, including MiFID, which placed value on both lit and dark activity.
However, other asset managers are having a different experience with the tax. Sören Steinert, associate director, equities, at Germany-based Quoniam Asset Management, said broker reactions had been varied, causing confusion and frustration for buy-side desks.
"Some brokers are offering the buy-side a flat rate of 12 basis points and are paying the difference so they can route orders through their internal pools. Other brokers have shut down internal pools for Italian stocks, or simply continued operating them by passing on the full 22 basis point cost to the buy-side client," Steinert said. "It's adding time, costs and bureaucracy for the buy-side. For example compliance teams must work to understand the details and traders have to look at the impact on trading in Italian stocks."
According to data from Markit BOAT, which provides daily reports on the aggregate activity from six BCNs on a country-by-country basis, trading of Italian stocks in BCNs has plummeted around 85%.
The six BCNs that report to Markit BOAT traded €55.5 million on 28 February, the day before the Italian FTT came into force, dropping to €8.5 million on 11 March.
Despite the initial impact this data suggests, AXA Investment Managers' Squires believes the tax would not have a significant effect on most buy-side firms.
"We appreciate the option of trading this way, but this tax will not have a major impact on our business," he said. "However, it will affect stat arb firms and hedge funds that profit on small margins from trades."
Italy joins France in establishing a national FTT while also supporting plans to establish a pan-European FTT, although France's tax is limited to equities of Paris-listed stocks of companies with a market capitalisation of €1 billion or more. Portugal, also a pan-European FTT supporter, has said it will pursue a national FTT for implementation next year.
Eleven states in total back a European FTT, including Germany, but excluding the UK. A draft of the tax was agreed upon by the European Commission last month and is progressing through legislative channels via the 'enhanced cooperation' mechanism, which lets a bloc of at least nine states go ahead with a law if the Commission is in favour.
Market participants have warned the current aims of the tax are too broad, and will unfairly tax market participants outside of supporting euro-zone states.