The Alternative Investment Management Association has issued a Research Note assessing – quite unfavorably – the European Commission’s recent proposal for a financial transactions ta

What is the FTT?

The EC’s proposal, set out in September, would, in the event all the member states agree, hit all transactions of equities or bonds at 0.1 percent of value, and all derivatives transactions at 0.01 percent of notional value.

This is not a “Tobin tax,” though the proposal surely owes something to recent agitation on that subject. That tax, which was proposed by U.S. economist James Tobin just as the Bretton Woods system was expiring in the 1970s, was intended as a substitute for that fixed-rates system, addressing some of the same concerns. Accordingly, Tobin’s plan was aimed solely at foreign exchange transactions. Not only is the FTT proposal not aimed solely at forex, on its face it would not include spot forex transactions at all.

Also, Tobin had in mind a truly global levy. An EU FTT could not be that. A financial institution based outside the EU, in say New York or Hong Kong, that entered into a transaction with a, EU based company, would be jointly and severally liable with the EU entity for that charge, but this might simply  inspire creativity in avoidance strategies by those non-EU institutions.

What Are the Costs?

The AIMA paper contends that the planned FTT is fundamentally unsound. The chief executive of AIMA, Andrew Baker, summarized the point thus: The plan “will reduce or eliminate a vast amount of cross-border share and bond trading activity within the European Union, thus undermining the Single Market. And we are not talking about complex financial transactions but very simple buying or selling of shares undertaken by ordinary investors.”

The AIMA analysis, in its “Illustration A,” (above), sets out the way in which the tax could burden businesses to a degree far greater than its proponents contend. Any single product may pass through several stages between raw materials and final consumer, as there are several steps between farmer harvesting wheat and retail outlet, such as Tesco, selling pasta. Businesses at every stop along the way (farmers, wheat processers, pasta extruders) will naturally want to hedge their own operational risks in the financial markets, so the price of the finished product will reflect the repeated imposition of the FTT.

Some firms would seek to escape the tax by lessening their own hedging. But this raises two other problems. First, to the extent it happens it will demonstrate that the FTT is discouraging sound risk-management processes, leaving those businesses exposed to the risks whence the derivatives markets would otherwise have offered shelter. Second, the withdrawal of these pasta extruders from the markets will make the markets that much more illiquid, widening price spreads, “and exacerbating the impact on the cost of capital and price of finished products,” as the report says.

The costs of this tax, if not borne by the consumers of retail products, will be borne by investors, pensioners, and indeed everyone with a stake in a portfolio.

BlackRock Analysis

AIMA also presents in a table, as below, the results of a study BlackRock Risk and Quantitative Analysis presented to the House of Lords in November 2011. It indicates that the annual cost of the FT for any fund will depend not only on that fund’s turnover, but on the nature of the instruments it trades. For a fund trading in equity UK indexes, for example, the added cost will be only 1 basis point (0.01 percent) on its trading volume. But that figure rises to 257 basis points (2.57 percent) for an equity European active fund.

An investor in such a fund, who puts in 10,000 Euros when he is 40 years old in hopes it will grow and contribute to his financial security at age 60, will find when he turns 60 that the FTT alone has cost him 15,000 Euros over those two decades, 50 percent more than the amount originally invested.

In return for such costs, what benefits? AIMA contends that the FTT would “largely fail to achieve stated policy objectives” such as the reduction in market volatility, and in face would prove counter-productive.