FTT delay should not sway buy-side readiness

The UK's legal challenge to the proposed European financial transaction tax may lead to delays, but asset managers must keep up to speed to respond quickly when implementation details emerge, an expert has warned.

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The UK’s legal challenge to the proposed European financial transaction tax (FTT) may lead to delays, but asset managers must keep up to speed to respond quickly when implementation details emerge, an expert has warned.

The UK Treasury last Thursday lodged an appeal with the European Court of Justice challenging the ‘enhanced cooperation’ decision by 11 states to develop the FTT before the deadline to appeal closed last week.

The UK’s concerns relate to the extraterritorial nature of the tax, which will levy transactions on market participants based in one of the 11 countries regardless of which markets they trade on. The tax will also apply to instruments issued within one of those states regardless of who trades them. This means, for instance, an American asset manager trading a German security on the London Stock Exchange would be taxed, although neither the US or UK have input into the details of the tax.

The UK’s legal challenge, coupled with a broad consensus of the supporting member states that a January 2014 implementation would likely be pushed back, market participants appear to have more time to adjust to changes.

But Mark Stapleton, head of tax practice for law firm Dechert, has advised buy-side clients to remain vigilant. 

“Market participants  must monitor the potential impact of the tax because it still could have far-reaching changes to their business, particularly with respect to the repo market and fixed income transactions,” Stapleton said.

“Because of the legal challenge and the fact that member states proposing to implement the tax recognize that the January 2014 implementation date is optimistic, the tax will likely come into force later than expected and will most likely undergo further changes to the initial draft,” he said.

The UK’s legal action is supported by the City of London, which last month released a report that found the impact on the UK’s fixed income market alone would total some £4 billion. Other states may follow with legal action, including the US, although no formal challenges have been made.

The UK’s challenge was a largely defensive manoeuvre, believes Jorge Morley-Smith, head of tax for UK buy-side trade body the Investment Management Association (IMA).

Treasury lodged the legal action last week because it feared there may be no other point to submit a legal challenge because there is no legal precedent around the enhanced cooperation tool. Until now, the UK has voiced supported the use of enhanced cooperation for the FTT, and abstained from the November vote.

Regardless of the outcome of the legal challenge, Morely-Smith believes consensus between the 11 member states will be hard to achieve.

Early reports from initial negotiations between the 11 member states to establish the details of the tax have led to a divergence of views, with France reportedly pushing to instate a version of its national FTT, and other states raising concerns over the ramifications for the sovereign debt market and pension funds.

“It’s entirely unclear as to what will be agreed by the member states and they could finalise a tax that is very different from the Commission’s proposal,” Morely-Smith said.

Smith added that the market reaction to FTTs implemented by France and Italy, two supporters of the pan-European tax, may also signal that an EU FTT may lead to unplanned – and adverse – outcomes for market participants, globally.

The French tax, in force since August last year, incurs a 0.2% levy on equity trades of Paris-listed stocks with a market cap of €1 billion or more, and has seen a reduction in liquidity of French stocks.

In Italy, an FTT in place since March taxes equity and bond trades at 0.12% and OTC equities (i.e. trades executed in broker dark pools) at 0.22%. This has also seen a drop off in trading volumes, and has led to brokers use a technique of ‘off-market, on-exchange’ trading, where transaction details are finalised in a dark pool, but execution occurs on an exchange of multilateral trading facility as a negotiated trade.

“Lessons can be learned from the French and Italian taxes, but the proposed European tax is much wider in scope and there are provisions to prevent market participants from simply accessing other markets outside the FTT-zone,” he said. “This means that market participants will find it harder to circumvent the 11-country FTT than have done with the French and Italian FTT.”

As currently drafted, the FTT will tax equity and fixed income transactions at 0.1% and derivatives at 0.01% of notional value and is expected to net €30-35 billion annually, according to Commission estimates. An initial draft of the tax has received widespread criticism for its universal nature.

The current plan would tax trades of instruments issued in one of the supporting states, regardless of where they are traded, and transactions by market participants based in one of the member states, regardless of where it is performed.

The 11 countries supporting the tax are Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia.