While the industry agonizes over capital requirements for Basel and implementation of the Dodd-Frank Act, there brews a storm in Europe with the potential to affect the markets in the U.S. more profoundly. While investor nervousness still rules the day, an across the board tax may not be the answer.
The FTT (Financial Transaction Tax) is gaining momentum in the EU as a solution to two main issues—the lack of government revenue and the activities of speculative high frequency traders. The FTT would be 1 basis point (0.01%) tax on the buyer and on the seller for transactions of bonds, stocks and derivatives - for a total of 2 basis points per transaction.
This tax has been called a Tobin tax, but it was originally proposed during the Great Depression (1936) by John Maynard Keynes. When an idea is born out of crisis, it may be sired by desperation. It is currently supported by 11 nations of in the Eurozone, with primary opposition from the U.K. and Sweden. The U.K. has indicated that it could support the FTT if it were to be implemented globally. As it stands, the FTT is scheduled to take effect on Jan. 1, 2014.
The markets have become more complicated and the effects of a transaction tax could use more research. There are several hurdles for the FTT to overcome but I wonder about two main scenarios: 1) European Implementation 2) Global Implementation
The European implementation seems poised to add friction to a market that needs more investment, not more reasons to avoid it. With deflation of fees becoming more commonplace (e.g., index funds with fees of 10 basis points) an extra 20%, assuming a sell and a buy, seems out of touch. The speculation regarding HFT (high frequency trading) presumes that it occurs mostly in equities, so how does a tax on bonds or derivatives do anything for that issue? Interest rates are at the lowest level in history, so will we diminish returns further?
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With about $600 trillion in derivatives notional outstanding, there seems to be more at play here. It would appear to be a protectionist measure which raises many questions during a global search for growth. Given the ongoing global effort to stabilize large financial institutions and implement the Basel capital rules, this seems inconsistent with the current environment of cooperation.
A global implementation, at least, would discourage the establishment of offshore entities to get around these transaction taxes. There are significant deficits in all of the countries considering the tax, so it does address shorter term needs. A poll in Europe found that voters supported the tax by a 70% to 30% margin. There are considerable tail winds behind these ideas.
The U.S. has considered a 3 basis point tax, but it has not advanced. U.S. Sen. Tom Harkin and U.S. Rep. Peter Defazio submitted legislation for consideration this year with the same figure. It would be helpful if there were a consistent global approach with a clearer purpose.
When I analyze equity options, the understanding of volatility is a key to how I add value for clients. As I have tried to model volatility, the liquidity of markets is a crucial component. A transaction tax would seem to reduce liquidity and therefore contribute to volatility. As we debate the unintended effects of QE and central bank intervention, let’s make sure we fully understand the impacts of a broad based financial transaction tax.
Disclaimer: The views expressed are those of the author and do not necessarily reflect the views of Wilmington Trust, its affiliates, or other associates.