1/4% Tax on all stock trades pushed in NY Times today

Part 1:

French transaction tax loophole could prompt tougher European regimes
Author: Tom Newton
Source: Risk magazine | 10 Jan 2013
Categories: Equity Derivatives

France went first with its new transaction tax regime – and found that leaving derivatives outside its scope created a loophole. Italy is up next and is set to fix that problem with a broader tax. Could other European nations follow suit? Tom Newton reports
In 1984, Sweden launched its first financial transaction tax (FTT), a 0.5% levy on equity trades. Over the next six years, it was refined and extended to other asset classes, including bonds and derivatives. The results were stark. Roughly half of Swedish equity trading migrated to London. Bond trading volumes dropped 85%, even though the tax rate was just 3 basis points. The volume of futures trading fell 98%, and the options market effectively disappeared.

It’s an old story that has become newly relevant, as 11 European countries prepare to introduce a common transaction tax. The big question for dealers is whether over-the-counter derivatives will be caught – traders argue a tax would decimate the market – and the debate has taken a worrying turn for the industry in the past couple of months.
In France, a member of the 11-country bloc that introduced its own tax on cash equities last August, authorities have said they could act to prevent the levy being evaded by using untaxed derivatives to take equity market exposure instead – implying an expansion in the scope of the tax. In Italy – another member of the FTT bloc to move early – the country’s Senate voted through a budget on December 20 that includes a tax on both cash equities and equity derivatives. That is thought by some observers to be a reaction to the problems France is experiencing with its tax loophole.
The commission closely monitors the experience of member states that have introduced an FTT
And the fear among dealers is that the common FTT slips back towards an original proposal published by the European Commission (EC) in September 2011, which included a blanket 0.01% levy on the notional value of all OTC derivatives. In a statement to Risk, the EC confirms it is keeping an eye on early adopters of the tax.
“The commission closely monitors the experience of member states that have introduced an FTT, even where such national taxes differ significantly from the one the commission proposed last year,” says a spokesman for the EC’s taxation commissioner, Algirdas Semeta. The spokesman adds that the EC still considers it feasible to tax all derivatives, as per the original proposal.
To put it mildly, the industry disagrees. The EC’s levy of 0.01% might initially seem generous when compared with the 0.1% tax on other products, but it would have been applied to the notional value of OTC trades. The EC accepts that notional values can grossly overstate the economic value of a transaction, but claims it would be easier to apply.
It would not, though, be easier for the market to bear. The EC’s impact assessment predicted derivatives volumes could fall by up to 90%, and it’s not hard to see why even an apparently small levy would have a massive impact.
“The fees are actually astronomical. If you compare the proposed charge of 0.01% to existing exchange and clearing fees, then it’s a multiple of those costs. For exposure to €1 million worth of three-month Euribor, exchange and clearing fees might typically amount to 25p. The proposed tax would add an extra €100 in cost,” says Guy Simpkin, head of business development at Bats Chi-X Europe in London.
The EC proposals resulted in stiff resistance from a number of countries, among them Sweden and the UK, but gained a new lease of life when a subset of European states decided to develop an FTT of their own, using an EC procedure known as enhanced co-operation, whereby a coalition of like-minded member states can implement legislation without the support of all 27 European Union countries (Risk February 2012, pages 26–29). And although France decided to go early rather than waiting for the process to run its course, it baulked at introducing a blanket derivatives tax – despite strong public support for measures designed to rein in trading.
“If you looked at the way the French tax was designed, then you knew there was a disconnect between the political rhetoric and the reality. In all honesty, I don’t believe the tax was intended to be very punitive, as French policy-makers knew they risked shooting themselves in the foot,” says Jiří Król, director of government and regulatory affairs at the Alternative Investment Management Association in London.
On August 1 last year, France went live with its version of the transaction tax. The taxe sur les transactions financières applies to the equity instruments of companies headquartered in France with a market capitalisation greater than €1 billion – currently catching 109 stocks. Originally set at 0.1% of each transaction’s value, it had doubled to 0.2% by the time the law was adopted by the French parliament on February 29.
Almost as soon as the tax was introduced, reports emerged that market participants were looking for ways to dodge it – and derivatives markets, listed or OTC, were the obvious dodge. “Market participants can just switch to derivatives, either through their brokers or directly on the listed markets,” Dominique Ceolin, chief executive of hedge fund ABC Arbitrage in Paris told Risk last November.
That translated into increased demand for equity swaps and contracts for difference (CFDs), say traders, as clients sought leveraged, synthetic exposure to movements in the underlying French equities without having to pay the tax. Industry sources estimate monthly cash equity volumes are down around 10% since the tax was introduced – which chimes with figures compiled by NYSE Euronext in November. At the same time, anecdotal evidence suggests CFD volumes have increased by as much as 25%.
Ironically, dealers are said to have been using the market-maker exemption the French tax grants to dealers in cash equities to hedge their tax-dodging OTC trades, according to one London-based market expert. “What is clearly happening is that banks are writing more equity swaps and CFD business with customers, and then using their market-maker exemption to trade stocks on the exchange as a hedge,” he says.
The upshot of the loophole’s exploitation is that the tax may not bring in as much money as the French authorities had forecast, says Jorge Morley-Smith, head of tax at the Investment Management Association in London. “There are a lot of rumours about the rate of the tax increasing” as a result, he adds.
Increasing the rate of the tax might – temporarily – help fill a revenue shortfall, or it might simply encourage more market participants to turn to the derivatives market. Another possibility is that the scope of the tax could be widened, to close the loophole.
In an emailed comment to Risk in November, the French tax authorities signalled they were alert to the issue. “We will be very careful on the risk of bypassing and tax evasion through synthetic instruments and take appropriate measures where needed,” wrote Laurent Martel, tax adviser to Pierre Moscovici, the French finance minister.
While no concrete proposals have emerged as yet in France, the baton has been seized by Italy. On December 20, the country’s Senate voted through its own tax applying a 0.1% charge to equity transactions in Italian stocks with a market capitalisation over €500 million, as well as a levy on equity derivatives where the underlying is a taxable Italian stock.
The original draft of Italy’s tax went further than the EC proposal, suggesting a higher rate of 0.05% on the notional value of derivatives. However, the country’s own impact assessment projected an 80% fall in volumes, and Italian lawmakers significantly pared back the tax in the face of intense industry lobbying. The law now prescribes levies for each counterparty, which vary according to the type of trade – ranging from €15 for a listed equity derivative to €200 for an OTC equity swap – according to Ernst & Young. The decision to leave equity derivatives within its scope may well be a direct response to the French experience.
“By including a tax on equity derivatives, the goal is to avoid any possibility that people can avoid paying tax on cash share transactions,” says Marco Ragusa, a tax partner in Ernst & Young’s financial services division in Milan.

 

Part 2:

Dismay
It makes sense from the point of view of the tax, but dealers are dismayed. Every bank approached by Risk for this article declined to speak on the record, but two traders that commented anonymously said the Italian equity derivatives market would die if a tax was introduced.
Die, or move elsewhere – which is the other way to dodge a tax. If Italy and France have an FTT, while other EC countries do not, then investors could simply decide to look for similar stocks elsewhere. That is the point of the enhanced co-operation regime, which the European Parliament approved on December 12 last year, giving the green light to Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain. Investors will find it tougher to avoid trading stocks in all these states – but it’s not impossible, so a further key element in the design of the shared FTT will be its geographic reach, and observers are already warning that attempts to catch market participants based outside the FTT bloc could run into obstacles relating to Europe’s single market rules (see box).
Both the French and Italian taxes make another, crucial departure from the EC proposals – the market-making exemption that allows dealers to hedge their OTC trades without being subject to the levy. And ensuring such an exemption in the final pan-European FTT is the number one priority for industry lobbyists.
“As long as we get an exemption that works, the direct impact on the big institutions is muted. If we don’t get an exemption that works, then you’ll see a very, very rapid impact on liquidity,” says one senior regulatory affairs official at a large international bank in Brussels.
In essence, the design of the FTT regime is a delicate balancing act between the desire to bring in revenues and the need to avoid damaging the market – tilt it too far towards revenue generation and it becomes self-defeating, causing market participants to flee and volumes to dry up.
France and Italy are both feeling their way through these economic realities, and although the latter is heading towards a scheme that is tougher than the French version, both countries are significantly softer than the EC proposal. But tilting the balance in this direction means a less ambitious revenue target. Of the €57 billion revenue the EC estimated its tax would rake in, around 67% came from derivatives – with 52% alone from taxes on interest rate products. Countries that exclude derivatives, exempt market-making activity or only target equity derivatives may be disappointed by the revenue take and look again at strengthening the levy.
This leaves the enhanced co-operation countries with some awkward choices to make, and more nations are preparing to introduce their own, national tax before the talks conclude. On December 12, Hungary passed its 2013 budget that includes provisions for an FTT, while both Portugal and Spain are also reportedly preparing to implement a tax.
The EC’s job will be to conjure up a regime that harmonises the different national schemes of the member states that support it. But as each state develops its own tax in line with its own requirements, that task will become ever more difficult, observers say.
“Those countries that have set their stalls out earlier will be arguing in favour of their model over anybody else’s,” says Simpkin at Chi-X Europe.

BOX: Suits vous? The case for bespoke tax
When the European Commission (EC) proposed its original, broad financial transaction tax (FTT) – on cash and derivatives across all asset classes with the exception of spot foreign exchange – it had one powerful, practical argument in its favour: if everyone joined in, then it would be tough for market participants to avoid. But with consensus absent, countries that go it alone are having to take a more modest approach.
“When individual countries introduce an FTT, it’s very difficult for them to do it in a way that is as broad as the commission’s original proposals. Any individual country that did so would risk decimating their financial markets,” says Jorge Morley-Smith, head of tax at the Investment Management Association (IMA) in London.
Both France and Italy have tried to tailor their domestic regimes in a way that ensures their tax base does not simply flee to untaxed jurisdictions – their solution was to collect the tax on companies incorporated in the country, rather than by tying it to the location of the exchange or the counterparties to the trade.
“The authorities tailored the tax cleverly. By basing the eligibility on the location of the issuer, and not the location of the intermediary, they avoided the risk that financial intermediaries would just redirect trading activity via London or other financial centres,” says Dan Toledano, product manager for the French transaction tax at Euroclear France.
It’s an issue the EC covered in its proposal, adopting what it called the residence principle – residents of the European Union (EU) should pay the tax on all transactions that were liable. But residence isn’t only a geographic principle in the EC proposals – it also captures any market participant trading with, or on behalf of, an EU institution (see figure 1).

“The most interesting thing to watch will be the authorities’ attempts to prevent the relocation of activity. Some of the anti-avoidance measures being floated are really pretty drastic,” says Jiří Król, director of government and regulatory affairs at the Alternative Investment Management Association in London.
In a briefing note specifically on the danger of trading volumes relocating, the EC clarified its thinking. The aim is to keep the reach of the law as broad as possible, it said – so if the US branch of a German bank seeks to hedge currency risk by executing a foreign exchange swap with a US bank, both parties would be liable for the tax. The obvious question is how the European authorities would know about the trade – observers say it would place some of the tax collection responsibility on authorities in non-European countries and European countries outside the tax.
It’s a potential source of major contention if the tax cleaves the EU into two blocs - those that levy and those that don’t. If the latter still fears the reach of the tax, then it may question the benefits and freedoms of EU membership. “Reading between the lines – no member state will say it openly – but there are serious concerns about the impacts of the broad tax on the single market and its compatibility with the European treaties,” says Morley-Smith at the IMA

 

Lengthy Ernst & Young article on EU FTT proposal, the enhanced cooperation procedure, influence of non-participating countries, legal basis and possible legal challenges in European Court of Justice etc...

http://tmagazine.ey.com/insights/european-union-update-quiet-storm/

 

TD Ameritrade Blasts French Tax on ADR Trades

http://www.tradersmagazine.com/news/td-ameritrade-blasts-french-transaction-tax-110718-1.html

 

Read this good link. Confusing, it's a current article but it mentioned upcoming Q4 key dates and I think they meant 2012 not 2013.

Sounds like a FTT with extra-territorial reach will be voted down under QMV, which is being delayed for that reason.

If they pair down extra-territorial reach to survive QMV, it hurts the FTT zone members in terms of competition. That's also grounds for challenging a EC plan, but why would the advocates play that card?

Our biggest concern is no extra-territorial reach, not even French ADRs in the US, as is in the French FTT now.

We also want this FTT EC trial balloon shot down entirely. It may be on strong political footing in Germany and France, but I think it's on weak footing in reality. There are so many hurdles and legal challenges to come.

Plus, if extra-territorial reach is stripped out, FTT advocates may change their minds, get cold feet and abandon the FTT ship.

The E&Y report seems to tee up UK lawsuits against extra-territorial reach. FTT can't hurt them competitive wise, can't double tax their people as they already have a stamp duty tax and can't upset the single market. With it's current extra-territorial reach in the UK, it does all those things.

 

Excerpt: "There are efforts to combat the applicability of the French tax to U.S. securities trades. In December, SIFMA and the Investment Company Institute jointly authored a letter to the Internal Revenue Service asking it to take a position that a clause in the US-France Tax Convention of 1994 exempts U.S. trades of French stocks or their proxies from a stamp tax.

Although there has been no official response from the IRS, individuals close to the agency tell Traders that the IRS is in agreement with the two trade organizations.

On another front, Congressman Tom Price (R-Ga.) authored a bill in November that would bar the U.S. government from enforcing a tax by foreign governments on securities trades in the U.S. H.R. 6616 has six co-sponsors has been referred to the House Ways and Means Committee.

A paper put out by SIFMA for its members notes that the French government, by itself, is unlikely to enforce a tax on the trading of French ADRs in the U.S."

Green comment: I like the part about "a letter to the Internal Revenue Service asking it to take a position that a clause in the US-France Tax Convention of 1994 exempts U.S. trades of French stocks or their proxies from a stamp tax."

Extra-territorial FTT is probably in contravention of many US tax treaties.

 

English language report covering what Handlesblatt reported a few days ago:

http://www.offshoretrustsguide.com/asp/story/EU_FTT_Now_In_Sight____59167.html

An agreement on plans for a financial transactions tax (FTT) is due to be reached at the upcoming meeting of European Union (EU) finance ministers on February 12.[...]

[...]Although an accord on plans for the tax could have been reached during an earlier meeting of EU finance ministers on January 22, Germany and France are said to have asked for the decision to be postponed. German Finance Minister Wolfgang Schäuble and his French counterpart Pierre Moscovici will be absent from the January gathering, instead attending celebrations in Berlin marking the fiftieth anniversary of the Elysée Treaty. Reports stated that both ministers had insisted on being present to push through plans at this crucial stage of the proceedings.[...]

 

Sounds like a stall with hopefully not enough QMV votes for passage.

 

hopefulness does not constitute a good sign.

let's put the date on our calendar.

 

QMV on EC-FTT could take place 22 January. However France and Germany may want it delayed until 12 February as they may want to attend celebrations in Berlin marking the fiftieth anniversary of the Elysée Treaty.

A decision will be made tomorrow, 18 January.

http://www.europeanvoice.com/articl...-deal-on-financial-transaction-tax/76163.aspx