The European Commission on 14 February 2013 adopted a proposal for a Directive1 authorising eleven countries – Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia (the “FTT Zone”) – to proceed with the enhanced cooperation procedure to enact a Financial Transactions Tax (“FTT”). This effectively clears the way for these countries to establish the levy based on the ideas of economist James Tobin to recoup the cost of the financial crisis from financial institutions.
Under the proposed Directive, provided a financial institution is involved with the transaction, a 0.1% tax would be imposed on trades in certain financial instruments with a reduced 0.01% rate for transactions in derivatives.
The scope of the tax is wide and covers capital market instruments, money market instruments, units or shares in funds, as well as companies and derivative contracts. It also includes trades effected over-the-counter. Transactions between companies in the same group are also within scope. In addition, each material modification of a taxable financial transaction will be treated as if it were a new taxable financial transaction. Structured products covering tradable securities or other financial instruments offered by way of a securitisation, as well as redemptions of shares or units in a fund, are also potentially covered by the tax.
The scope of the Directive is defined by two main principles:
The “residence principle”, which catches financial transactions where
at least one party is established in a participating Member State; and
a financial institution, acting either on its own account or for a client, established in a participating Member State, is involved in the transaction.
However, CCPs (Central Clearing Counterparties), CSDs (Central Securities Depositories) and Member States’ own entities managing public debt are exempt from the charge (although their counterparties may not be).
The “issuance principle”, which deems persons who deal in financial instruments (other than certain OTC instruments) as established in the country of issue, where that country is a participating Member State.
Thus, any financial institution dealing in financial instruments would be affected by the tax if its registered seat or the branch carrying out the relevant transactions is located in a participating Member State, or if the instruments subject to the transaction were issued in a participating Member State.
The uninitiated could be forgiven for thinking that the tax would be limited to financial institutions within the FTT Zone. However, it is clear that the existing proposal has very substantial extraterritorial effect, and there are a whole range of practical examples that demonstrate the potential extraterritorial scope of the tax. For example, if a Cayman hedge fund chooses to effect a transaction by appointing a French investment manager, this would appear to create an exposure to the FTT that might not be created if the fund instead were to appoint a UK investment manager. A further example is that dealings in the shares or units of a fund based outside the FTT Zone, by a financial institution within the FTT Zone, will still be within the scope of the tax. This is a concern not only for FTT Zone financial institutions, as the proposed Directive makes all parties to the transaction jointly and severally liable for the tax, which should generally be paid to the tax authorities of the Member State of the relevant FTT Zone financial institution.
A further interesting point is that it is clear a non-FTT Zone branch of an FTT Zone financial institution (for example, a French bank that has a branch in London) would be within the tax with respect to dealings conducted by the branch. However, this would not necessarily be the case if the French bank had a UK subsidiary with a London operation that effected the same transactions.
The position with respect to agents acting on behalf of financial institutions also appears quite complicated. On the one hand, the Directive clearly states that transactions by financial institutions in whatever capacity (i.e., even if acting as agent on behalf of another person) are within the scope of the tax. On the other hand, the payment and liability provisions indicate that liability does not belong to the agent, but rather to the financial institution for which the agent was acting. This is expressed to be designed to counter the potential concern over the “cascading” effect of the tax – where one economic transaction might be represented by a number of different financial transactions involving different financial intermediaries. However, it would appear that this provision does not prevent multiple charging in respect of the one economic transaction – rather, it may simply clarify that it is not the agent but the principal financial institution that is liable for the multiple tax charges.
The tax is chargeable for each financial transaction at the moment it occurs, whether or not the transaction is subsequently cancelled or reversed. The charge of 0.01% on derivatives and 0.1% on other financial transactions is calculated on the basis of consideration paid, unless that consideration is lower than the market price or the transaction is an intra-group transfer of the right to dispose of a financial instrument and transfer of the risk. In the latter instances, the charge will be calculated on the basis of the consideration that would have been paid had the contract been at arms’ length (i.e., market value).
It is early days for the Directive, as it will now be amended according to the Member States’ views. Furthermore, internal tension in the governing coalition in Germany may influence the German position on legislative proposals. Some conclusions, however, may already be drawn.
First, as the tax is calculated per transaction, it appears that high frequency trading (“HFT”) and algorithmic trading will be harder hit than long-term holders who execute relatively few trades. It may well lead to a total review of how and where such HFT activities operate.
It is also clear that there is no European unity on the proposal, despite Commissioner Šemeta’s calls and hopes for the rest of the EU states to join the eleven2 who may introduce the tax as early as 1 January 2014. It remains unclear what the effect will be on the single market. As AIMA CEO Andrew Barker noted:
[T]he EU’s proposed financial transaction tax 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.3
It is clear that the proposed FTT Directive is a cause for major alarm and concern. However, the question that arises is what can be done at this point and by whom? It seems most unlikely that the European Commission or the participating Member States will be interested in the views of the hedge fund or indeed investment management sector, particularly if those views emanate from outside the FTT Zone.
If a loud enough message is delivered to the governments of non-participating Member States (and indeed non-EU governments), even if a challenge based on the legality of the tax does not emerge, it may prompt such governments to press for the introduction of important modifications prior to the increasingly likely adoption of the FTT. In particular, it appears that considerable work needs to be done to ensure that multiple charges do not arise in respect of a single economic transaction, and exemptions could be introduced for intermediaries to clarify the position. Further, it seems surprising that exemptions have not been introduced for UCITS funds or pension funds, given the potential impact on individual savers and pensioners.
*The authors would like to thank Chris Von Csefalvay for his research for this article.