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Letter sent to the President of the ECOFIN Council by IBFed to express its opposition to the proposition of a Financial Transaction Tax
Mr Michael Noonan
President of the ECOFIN Council
Ireland Minister for Finance
23rd April 2013
Dear Mr. Noonan,
Re: IBFed |1| Comments on the European Commission's proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax
The IBFed would like to express its strong opposition to the decision taken by the European Commission (EC) to allow its proposal for a financial transaction tax (FTT) to be pursued through the Enhanced Co-operation Procedure. We set out below our broad concerns over the FTT, while the Annex provides more detail on the potential impacts of the tax.
Numerous governments, independent research studies, financial market experts, tax experts, and prominent market commentators have all expressed their concerns over an FTT and identified its many shortcomings. These concerns are based on the negative impact the tax would have on market efficiency and liquidity, its harmful economic impacts, its hindrance to achieving regulatory objectives, and past failed experiences with an FTT in other jurisdictions.
While some supporters feel that FTTs often fail to achieve their objectives because many jurisdictions do not participate in multi-jurisdictional FTT proposals, we believe the lack of participation is actually recognition of the failings of FTTs. The IBFed is worried that the EC and some EU Member States fail to understand that the reluctance of a majority of EU Member States to participate in the FTT proposal is due to their negative assessment of its merits.
Continuing to pursue an FTT in these circumstances has resulted in a design that makes a bad tax even worse. To deal with the consequences of tax avoidance, this proposal adds complexity and inappropriate extraterritoriality that produce economic inefficiencies by creating an unnecessary deadweight loss. The fact that these inefficiencies are transmitted through the financial sector should not be taken to mean that the costs are not borne by ordinary citizens or taxpayers. They will bear the burden of this tax but will do so in unexpected and opaque ways. The cascade effect of the tax also means that it will be most pronounced on end users such as non-financial corporates and Small and Medium Enterprises.
Extraterritoriality: making a bad tax worse
The IBFed is extremely concerned over the broad scope and extraterritorial nature of the FTT. A large number of the IBFed's member banks are established in "non-FTT jurisdictions", but will nevertheless be subject to the tax because of its extraterritorial scope. We strongly believe that the extraterritorial scope of the proposed FTT runs counter to internationally accepted tax principles and creates an unnecessary deadweight loss.
Those outside the FTT jurisdictions will seek to minimize their financial transactions and engagement with financial institutions which give rise to the FTT, and will also attempt to protect themselves from costly compliance whenever possible. They will begin to reduce their exposure to financial institutions and businesses within FTT jurisdictions, even though they are home to some of the largest financial institutions and businesses in the world. Since capital is highly mobile, we expect financial instruments issued in FTT jurisdictions, including government debt securities, to be quickly and negatively impacted as the tax gets factored in to the purchase decision. Governments which already find it difficult to sell their debt will find it even more difficult in the future.
In addition, the FTT will be a deterrent for counterparties in non FTT jurisdictions and they will demand rate or price adjustments to compensate for the tax. Other counterparties may choose not to transact with financial institutions or in financial instruments subject to the tax since they do not want to bear, directly or indirectly, the cost of establishing the infrastructure required to submit the tax. The end result would likely be a reduction in the profitability, size, and strength of financial institutions within the FTT jurisdictions, with a detrimental effect on the non-financial economy within these jurisdictions. Supporters of this proposal appear to have a naive view of how markets work and how that behaviour affects tax incidence. It is that behaviour which will lead to most of the costs being borne within the FTT jurisdictions. However, due to the extraterritorial nature of the tax, non-FTT jurisdictions will also bear some of the burden of the tax.
We believe that such a development could not only lower other forms of tax revenues, but would also unfairly marginalize financial institutions in the FTT jurisdictions. In the end, we believe that the costs of reduced economic activity in the FTT jurisdictions will far outweigh the perceived benefits of the tax revenues that will be collected under the FTT regime.
We also note that the impact analysis suggests that the FTT will result in a significant decrease in market volumes, notably from market-makers, and a material reduction in the volume of derivatives which financial institutions use to manage their risks. The EC appears to welcome such a "structural break", which in their view will force financial institutions to change their business model and encourage them to make longer term investments. We do not agree with this view. First of all, it presumes these activities are either bad generally or just bad if undertaken by financial institutions. Neither presumption is valid. While we understand that one of the objectives of the FTT is to curb high frequency trading, we believe that market making and risk management activities play an important role in the financial system. The IBFed does not believe that market making and risk management should be discouraged and that, if the concern is with respect to the behaviour of banks, the FTT is not a good policy lever.
We thank you for taking our comments into consideration and would be pleased to discuss these issues further at your convenience.
Mrs Sally J Scutt
ANNEX - Potential Impacts of the Proposed FTT
Financial Market Impacts
- Increased cost of funding - the cost of funding obtained from financial institutions in FTT jurisdictions would increase.
- Increased cost of FTT-related business - as a result of the "issuance principle", the cost of transacting in financial instruments issued in FTT jurisdictions would increase.
- Increased cost of repo funding - repos provide an important source of liquidity for financial institutions through the interbank market and through interactions with the central bank. The FTT would significantly increase borrowing costs in this market; in one simple example, the annual aggregate cost to both parties to a transaction could be as high as 252 x 0.2% = 50.4%. In addition, the FTT could also have implications for the use of repos as a monetary policy instrument.
Financial Stability Impacts
- Increased cost of diversification - the FTT would increase the cost of doing business with FTT jurisdictions or holding financial instruments issued in FTT jurisdictions and therefore increase overall concentration of financial exposures.
- Increased cost of hedging - when combined with the cascade effect, the FTT will significantly increase costs for both financial and non-financial institutions, which will reduce their ability to hedge against risk, which is inconsistent with other regulatory objectives. We believe that this is inconsistent with what regulators are trying to achieve from a risk management and systemic stability perspective.
- Increased deterrent to the use of central counterparties for derivative clearing - although Central Counterparties are exempt from the FTT, those institutions which transact with them are not. This may lead to an increase in transactions which are not cleared through CCPs, which is inconsistent with several other regulatory objectives.
- Increased risk to all market participants - the negative impact on market liquidity and the corresponding increase in volatility will increase risks for both financial and non-financial institutions.
- Dislocation of business away from the regulated sector - the FTT will create an incentive for customers to transact without involving financial institutions, and as such, business may be driven away from the protections offered by regulated marketplaces towards the shadow banking sector.
Wider Economic Impacts
- Increased cost for bank stakeholders - the costs of the FTT could be passed onto financial institution customers and other stakeholders through lower returns to depositors and investors, increased cost of credit for borrowers, and reduced shareholder returns.
- Tax cascading - the application of the FTT to intragroup transfers and multi-stage transactions may create cascading tax impacts on financial institution customers.
- Increased cost of savings and retirement products - the FTT will be passed on to financial institution customers (including residents of non-FTT jurisdictions) through its application to transactions initiated by or on behalf of investment and pension funds with financial institutions in FTT jurisdictions or involving financial instruments issued in FTT jurisdictions.
1. The International Banking Federation ('IBFed') is the representative body for national and international banking federations from leading financial nations around the world. Its membership includes the American Bankers Association, the Australian Bankers' Association, the Canadian Bankers Association, the European Banking Federation, the Japanese Bankers' Association, the China Banking Association, the Indian Banks' Association, the Korean Federation of Banks, the Association of Russian Banks and the Banking Association South Africa. This worldwide reach enables the Federation to function as the key international forum for considering legislative, regulatory and other issues of interest to the banking industry and to our customers. [Back]
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