In this insight, Judith Hardt, General Secretary of the Federation of European Securities Exchanges (FESE), and Christoph Boschan, Managing Director of the Stuttgart Bӧrse, explain why they are calling for changes in design of the planned Financial Transaction Tax (FTT).
When Europe’s stock exchanges meet today in Berlin for the annual conference of their umbrella organisation, the Federation of European Stock Exchanges (FESE), one of the main items on the agenda will be the planned Financial Transaction Tax (FTT). The choice of location is an appropriate one. Germany has led the way on the new tax and is one of the EU member states keen to introduce it under ‘enhanced collaboration’.
The initiative is widely regarded as a ‘stock exchange tax’; yet in reality, following a decade of deregulation, stock exchanges now handle a smaller proportion of all trading in securities, with the unregulated market attracting an ever increasing volume of transactions. Although both are affected by regulatory initiatives, the impact is often felt most by the regulated markets. They shoulder the cost of stricter regulation, while the over-the-counter (OTC) market in its current form benefits from the quality of stock exchange trading – OTC platforms have to use the transparent, liquid and independently supervised stock exchanges as reference markets.
This makes it even more important for stock exchanges to speak with a single voice. The FESE has assumed this role with regard to the FTT and has drawn the attention of member states and the European Commission (EC) to the potential consequences, arguing that the tax will not only undermine growth and employment but also make it more difficult for companies to access the capital markets. In the field of securities trading, the planned tax has the potential to create a competitive divide across the entire European securities market and the risk of unfair competition between stock exchanges and OTC markets.
Impact on markets
In fact, the greatest impact of the FTT will not be felt by the banks. The tax will affect the ability of companies to obtain capital. The willingness of investors to provide capital depends in part on whether they can sell their equities or debt instruments whenever they wish on a liquid secondary market. However, a FTT will entail higher transaction costs, a decline in trading volumes for those securities affected and reduced liquidity on the secondary markets. As such, the imposition of a tax has an indirect but substantial impact on the ability of companies to procure capital.
Market liquidity for securities will suffer even more from the FTT if, as Brussels intends, market makers and other liquidity providers are also required to pay. They form the backbone of an effective stock exchange trading system. Market makers are hugely important in regional, less liquid markets, where investor confidence depends on sufficient liquidity being available.
It should be noted, however, that the margins of liquidity providers are generally in the region of a few basis points, well below the level of the planned tax. Consequently, the income generated by these crucial market participants is not enough to pay the tax, and they would have to pass the tax on in full to other market participants. As a result, the tax would simply be multiplied along the entire transaction chain, a situation that the EC actually wanted to avoid. Liquidity providers should therefore be excluded from the FTT. Unfortunately, this particular solution has not found its way into the EC’s latest draft proposals. By contrast, the FTTs already implemented in France and Italy have excluded market makers as a matter of course.
Stock exchange tax
The term ‘stock exchange tax’ may be misplaced, but it does highlight one major issue: FTT will have a disproportionate impact on the highly regulated side of securities trading. This is contrary to the spirit of the 2009 G20 communiqué in Pittsburgh, which called for measures to strengthen regulated trading as opposed to the unregulated market. Italy took the right steps in this direction by imposing a higher tax on the unregulated trading of securities.
By contrast, the latest EC proposals strengthen the unregulated market. If the tax is imposed on both at the same rate, we can expect a major shift toward OTC trading, especially given that turnover in this area is much harder to identify for tax purposes. Even if the Commission does not share our assessment that those wishing to avoid the tax will migrate to the OTC market, stock exchange trading will nevertheless become more expensive, albeit indirectly. Much stricter regulatory standards will entail higher costs – to provide trading surveillance, for example, and to ensure transparency before and after trading. Market participants will do everything they can to reduce their costs and will therefore move away from more expensive stock exchanges. Incidentally, if we look at the trading fees on European stock exchanges, we can see that they are well below the tax rate proposed by the Commission.
Whether intentionally or not, strengthening the OTC business will further undermine regulated trading – with state help – and weaken the protection available to investors. At some point, we might find ourselves asking whether regulated stock exchange trading is still viable. If we see a further decline in liquidity on those stock exchanges, the dependable and transparent system of market pricing that we have become used to may be at risk, and that would have a profound impact on the entire economy.