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More criticism levelled at EU FTT

The Financial Transactions Tax (FTT) proposed by 11 European Union (EU) member states risks devastating the countries’ banks and leaving them dependent on central bank funding, according to Jens Weidmann, president of the Deutsche Bundesbank. This latest criticism of the FTT follows earlier attacks from ICMA and ICAP.

“From a monetary policy point of view, the financial transactions tax in its current form is to be viewed very critically,” Weidmann said. “Regulation is not an end in itself, and the costs and usefulness of any planned measure must be weighed against each other.

“Some effects cannot be seen immediately but can turn out to be explosive. An example of this is the planned FTT.” Although the tax had been fundamentally agreed “the unforeseen side effects can be substantial” he added.

As currently envisaged, the FTT would extend to asset-backed money market transactions or so-called repurchase (repo) agreements. Weidmann said that the repo market plays a central role in equalisation of liquidity between commercial banks.

“If it doesn't function properly, the transactions are deflected onto the Eurosystem [European system of central banks], and central banks will continue to be heavily involved in liquidity equalisation between banks well after the crisis,” he suggested.

IIF and Washington Voice Concerns
There was also criticism of the FTT from across the Atlantic, as the Washington-based Institute of International Finance (IIF), a global association of more than 470 financial institutions (FIs), released a position paper compiled by its Council on Asset and Investment Management (CAIM).

While acknowledging that the proposed FTT is motivated by worthwhile goals, CAIM raised concerns that any revenue it would generate would be considerably outweighed by the potential costs in terms of burden on end-users of financial services, potentially weaker economic growth and job losses. Overall, the FTT would likely prove ineffective and fail to meet its goals.

Among the key drawbacks noted in the position paper were the following:

• Burden on private investors: In line with the European Commission’s (EC) own assessment, CAIM members believe that a large part of the burden would fall on end-users of financial services: households and small businesses will not escape the tax burden. In particular, savers and pensioners would very likely experience lower returns on their investments.

• Risks to economic growth: The Council highlights the significant empirical evidence that suggests financial transaction taxes lead to lower liquidity, higher volatility, higher transaction costs, lower asset prices and a higher cost of capital - ultimately resulting in lower investment activity, job losses, and lower gross domestic product (GDP) growth.

• Higher cost to hedge risks: The EC itself expects a 75% drop in derivatives transaction volumes over time. This will affect not only ‘speculative’ trading but also essential hedging activities for risk management undertaken by both institutional investors and non-financial firms. Market participants with short-term hedging needs could decide to keep certain positions open, exposing themselves to undesired risks.

• Potentially dramatic impact on European repo markets: Transactions in the European repo market - some €5.6 trillion in size - play a vital role not only in bank funding but in investors’ short-term liquidity management and in monetary policy. As repos tend to be high-frequency transactions (e.g. overnight), a series of transactions could result over the course of a year in a cumulative tax liability of about 25% p.a. - which could severely inhibit this key market.

• Higher cost of sovereign funding: Taxation on secondary market transactions in government bond markets would have a direct and negative impact on liquidity and funding costs. This is particularly relevant for short-term bonds in a low interest rate environment, where the marginal cost of an FTT could be prohibitive. This would impair primary markets in these securities and reduce market access for countries already facing challenging market conditions.

• Concerns about extraterritoriality: With jurisdiction in only 11 EU member countries, an EU FTT would create a non-level playing field, with market participants within the FTT area placed at a competitive disadvantage. Given the very high mobility of capital, financial transactions, market activity and jobs could shift to preferred tax jurisdictions.

“An FTT would ultimately hurt savers and pensioners, at a time when many are already struggling to achieve adequate returns,” stated Walter Kielholz, chairman of the board of directors at reinsurer Swiss Re.

“Moreover, the FTT could greatly reduce liquidity and impair financial stability, particularly against the backdrop of still-fragile financial markets. Imposing such a tax would create additional headwinds to growth and job creation in Europe."

Richard Kushel, deputy chief operating officer (COO), BlackRock, added: “We are deeply concerned that the proposed EU FTT could create unintended investment incentives, contradicting the principles of sound investment management.

“We fear, for instance, that the tax could have a particularly negative effect on some of the most safety-conscious investors, whose portfolios invest in shorter-duration bonds, as these are subject to a greater number of transactions. Worse still, the tax would penalise hedging transactions and other forms of risk management.”