Plans announced by French prime minister Nicolas Sarkozy and German chancellor Angela Merkel to form a proposal for a financial transaction tax (FTT) are scant on detail but could theoretically be applied successfully to equity trades, according to City sources.
At a meeting held in Paris on 16 August to discuss the ongoing European government debt crisis, Merkel and Sarkozy committed to drafting a proposal by the end of September. The proposal is likely to cover the whole of the European Union, but few other details have been provided.
“This is no certainty on which instruments and market participants this tax could cover,” said Judy Harrison, senior associate, tax department at law practice Norton Rose. “For example, will there be an exception for those that hold financial instruments over long time periods?”
Press reports have suggested that the UK would veto the implementation of a transaction tax, which would severely reduce its effectiveness. If it decided not to take part in a FTT, the UK could see increased flow from investors looking to circumvent the levy. The appetite for a transaction tax from other European nations is also unclear.
“France and Germany can force a discussion on their own proposal but they can’t force a tax to be implemented on an EU-wide basis as it needs the agreement of all the member states – most of which have not stated their positions,” added Harrison
The European Commission (EC) would have to adopt the Merkel-Sarkozy plan or come up with its own scheme as the first step toward an EU-wide transaction tax. The EC is yet to indicate that this is something it is likely to do, despite being continually pressed by the European Parliament.
Richard Perrott, diversified financials analyst at London-based Bernenberg Bank, believes such a tax could be applied to the European equities market.
“The equity market is probably well placed to handle a financial transaction tax,” he said. “Products such as spot FX or exchange-traded interest rate derivatives have lower margins than cash equities, which would mean that liquidity in these markets would be more severely affected by a tax.”
The imposition of a transaction tax for equities would almost certainly dampen high-frequency trading activity, which is currently estimated to account for around half of European equity trading. High-frequency traders, who typically make tiny profits on many millions of low-margin trades, could see the profitability of their strategies decrease substantially if a FTT becomes a reality.
Since the financial crisis, the idea of a transaction tax has slowly gained support in political circles across Europe. In a vote in Strasbourg on 8 June, MEPs voted through an amendment that called for a FTT to be a future source of revenue for the European Union. The amendment was part of the parliament’s report on a new multi-annual financial framework to fund the European Union from 2014.
The Strasbourg voted followed a non-legislative resolution on innovative financing that was voted through on 8 March, in which the European Parliament voted for a tax on financial transactions, even if Europe was alone in doing so.
The Parliament stated that such a tax could “help to tackle the highly damaging trading patterns in financial markets, such as some short-term and automated high-frequency trading transactions, and curb speculation”. It added that a low-rate FTT could raise up to €200 billion per year and would increase transparency, reduce excessive price volatility and incentivise long-term investments that benefit the real economy.
Until further details emerge, Perrott suggests that the significance of Franco-German support for a transaction tax may be to remind the financial sector of prevailing political opinion.
“Maybe this tax won’t happen, but it shows there is still an appetite among politicians to punish the financial sector or look at ways of adding regulation to financial markets, which can only slow markets down,” he said.