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In the wake of the Great Depression, John Maynard Keynes developed the idea of using a financial transaction tax (FTT) to curb excessive speculation and volatility in financial markets. With 11 EU member states calling for the introduction of an FTT on certain financial products, Dan Neidle, a partner at Clifford Chance, considers whether the FTT would be effective in deterring harmful financial activity.
In 2011 the European Commission proposed an FTT that would apply to most financial products—equities, bonds, derivatives and interests in funds. The proposal required unanimous support among the 27 EU member states, but it became clear quite quickly that the UK and most other EU members would not support it.
The 11 member states that supported the FTT still wanted to proceed, and so applied the (rarely used) EU ‘enhanced cooperation procedure’, which lets nine or more member states proceed with a measure if they are agreed on it as between themselves.
However they have run into two significant difficulties.
The first is what the scope of the FTT should be. The original proposal was a very broad-based tax, of a type never before introduced in a developed economy—and many feared the impact a tax of that kind could have on businesses, investors and consumers. This led some to support a narrower tax, much closer to UK stamp duty or the recently introduced French FTT—both of which essentially apply to equities only. However, that is seen by many of the FTT supporters as insufficient at raising revenues and deterring transactions they see as undesirable.
The second difficulty is whether the FTT should apply extra-territorially. The original proposal applied whenever anyone, anywhere in the world, transacted with someone in the 11 participating member states. This ‘residence principle’ was and remains highly controversial, as it suggests companies and financial institutions in the UK, Sweden and other countries that aren’t participating in the FTT would still be affected by it. The legality of this under EU law is highly questionable.
The 11 participating member states have been struggling with these and other fairly fundamental questions, which is why almost two years later no progress has been made.
The stated objective is to deter harmful financial activity and to recover some of the costs of the financial crisis from the banks. However, neither is very persuasive. The FTT applies to all kinds of financial activity, much of which (eg hedging interest rate risk) had nothing to do with the financial crisis. In addition, the FTT applies to many different entities aside from banks—insurance companies, investment funds, pension funds, even charitable foundations. Even when it is a bank that is subject to the tax, if it is acting as an intermediary, it will presumably pass the cost on to its clients.
It is therefore not unduly cynical to assume there are two real reasons. First, bashing the financial sector is good politics (regardless of who actually bears the cost). Second, governments need all the revenue they can get.
That depends on which form the FTT takes—the original very wide formulation (in which case almost everything except loans and spot FX will be taxed), or the narrower stamp-duty kind of approach. The most recent statement from the 11 member states says they are now committed to a broad based tax, so it is probably prudent to assume it will, if introduced, apply widely.
There is a commitment to have at least some elements of the FTT in place by 1 January 2016. This seems ambitious, but we will have to see. It is impossible to say what the effect will be until we know what the FTT will look like. However, if they really do proceed to tax derivatives and debt securities that will potentially have a profound effect on the market, particularly given the way the FTT ‘cascades’ into multiple charges as transactions are cleared, settled and hedged. For example we have shown that many cleared transactions would be subject to as many as ten separate FTT charges.
There are so many uncertainties that at this point all we can do is watch and wait.
Interviewed by Barbara Bergin.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
First published on LexisPSL Banking & Finance. Click here for a free trial.
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