A financial transaction tax (FTT) in Italy will hit brokers’ internal dark pools, forcing some to re-route orders away from their own pools and raising concern over the potential impact on liquidity.
Enforced from 1 March, the Italian FTT will tax OTC equity trading at 0.22% for 2013, dropping to 0.2% thereafter, while trades on exchanges and multilateral trading facilities (MTFs) will incur a 0.12% levy in 2013, dropping to 0.1% in 2014. Derivatives will be taxed on a sliding scale depending on instrument and notional value of transaction.
The higher charge for OTC activity will encompass broker crossing networks (BCNs), which are currently classified as a subset of off-exchange trading under MiFID.
While BCNs are highly likely to fall under the new organised trading facility (OTF) category defined under MiFID II, or shoehorned into existing multilateral trading facility or systematic internaliser categories, this is not expected to take effect until 2015.
As such, market participants predict a significant reduction of liquidity in broker dark pools for Italian stocks.
“This is essentially a relatively short-term politically motivated money-raising exercise. It is not part of a more comprehensive legislative agenda to tax dark pools out of existence,” a director of a investment bank, speaking anonymously to theTRADEnews.com, said. He added that non-Italian investment banks with internal dark pools will be hit hardest, while national exchanges will benefit from increased liquidity.
Brokers may have to alter their routing systems to avoid higher fees in internal dark pools for Italian stocks and act more as an agency venue aggregator, according to Paul Squires, head of trading for asset manager AXA Investment Managers.
“We’ll probably see more Italian flow go through the recognised exchanges and an associated drop off in Italian flow through broker pools with possibly an increase in instruments that offer synthetic exposure to Italian stock,” Squires said.
“Ultimately, it will be more expensive to trade in block sizes. Dark pools exist to match up natural liquidity, which is by definition an ideal market function,” Squires said.
Investment banks are scrambling to alter IT systems to comply with the new rules, which were first mooted in December as part of the Italian budget. They include a market-making exemption although a lack of details has caused concern for sell-side participants looking to comply.
Carlo Galli, an Italian tax partner for law firm Clifford Chance, believes the absence of market consultation may inhibit compliance and said the Italian government may adopt the market-maker exemption developed by the European Securities and Markets Authority (ESMA) for its short-selling rules.
“There’s a lot of uncertainty and ambiguity in the law over the scope of the market making exemption and now they are trying to fix it in the implementing legislation by making reference to the ESMA Final Report of February 1,” Galli said, adding that Italy’s support of a pan-European FTT suggests the national tax meets immediate political goals.
“This Italian tax may be short lived because the European tax is very different, however Italy is concerned the scope of the forthcoming European tax is too wide as it captures state bonds, which Italy does not want to sign off on because of the high number of such products in the market,” Galli said.
Galli added that because the Italian tax hits the ultimate transferee it will not apply to intermediaries of a transaction, but this means it will hit end-investors rather than financial institutions.
The Italian FTT will incur an additional 0.02% fee on high-frequency trading and will postpone payment of the tax for three months, although market participants will need to begin collecting the tax from March.
The tax on derivatives will be divided into three tiers with swaps taxed highest followed by futures and options on shares, while swaps or futures related to yields and options on shares would constitute the lowest tier.
Italy joins France, Spain and Portugal in having – or developing – an FTT. Details released yesterday on a pan-European tax have caused widespread concern over its remit. It is expected these national taxes will be subsumed into the broader European FTT, which is currently backed by 11 European states.