When the European Economic Community, the forerunner of the European Union, was founded in 1957, its main goal was promoting peace. While the EEC’s and EU’s member states have avoided military conflict since then, things are somewhat less harmonious on the economic front. There has been more than a little bickering over the bailout of struggling eurozone sovereigns and this week has seen a war of words erupt between British prime minister David Cameron and France’s president, Nicolas Sarkozy.
At the heart of the hostility lies a financial transactions tax (FTT), sometimes dubbed a ‘Tobin Tax’ after economist James Tobin, who proposed a levy on currency transactions four decades ago. Calls for a Europe-wide financial transactions tax have been growing since the onset of the credit crisis, with some viewing the tax as a means of making banks repay the taxpayers who bailed them out.
Last year the European Commission set out a proposal for a tax to be applied across the EU’s 27 member states, which it hoped would “ensure that financial institutions make a fair contribution to covering the costs of the recent crisis”. It proposed a rate of 0.1 percent on trades in stocks and bonds and 0.01 percent on those in derivatives. Other stated aims include the avoidance of fragmentation in the financial markets and the creation of disincentives for transactions that do not increase the efficiency of the financial markets. Here, it seems, the EC has in mind the high-frequency trading that many blame for recent ‘flash crashes’.
While the idea has drawn some support from political, community and religious quarters, opponents to such a levy have been numerous and vociferous. BlackRock, for example, in a submission to the House of Lords, says it would be likely to have an effect opposite to that envisaged by policymakers. “Contrary to the intentions of policymakers, an FTT will reduce liquidity and increase volatility in the marketplace,” BlackRock argues.
The firm also points out that the cost of the tax would be borne by end-investors rather than by banks. MJ Lytle, managing director at ETF issuer Source, takes a similar view. “The big issue with this proposed tax is that it does not do what it is apparently trying to achieve—that is, to target banks. The tax does not target banks because if banks incur a cost they will pass it on to investors. If you are trying to lean on the revenues of banks this is not a particularly good way to do it.”
It is perhaps understandable that, by and large, the financial services industry opposes the tax. After all, even if they do pass the tax on to consumers, they still stand to lose out if transaction volumes fall as a result of its introduction. Interestingly, however, there are also some high-profile supporters within the financial community, such as the FSA chairman Lord Turner and financier George Soros.
In any case, after David Cameron voiced such staunch opposition to the tax that he threatened another EU veto earlier this year, most considered it impossible that a financial transactions tax would get the backing of all 27 member states, and that it was highly unlikely that any countries would choose to go it alone.
Fast forward to this week, however, and some form of an FTT looks much more likely. Sarkozy announced plans for France to introduce its own FTT if he is elected for another term in the upcoming presidential elections. Europe’s other powerhouse economy, Germany, appears to be undecided; although it initially supported France, it favours a Europe-wide tax and wants to get Britain on board.
But while an FTT will undoubtedly introduce more costs for all types of financial transactions if implemented, it may not necessarily be a bad thing for the exchange-traded funds industry.
In fact, the tax could increase the appeal of ETFs. BlackRock’s aforementioned submission to Parliament includes a table illustrating the impact of the tax on various investments. It puts the additional cost imposed by the tax at just 8 basis points (bp) for a fixed income euro ETF, while the burden on a fixed income euro active fund is three times higher, at 25 bp.
Lytle says this would increase the pressure on active funds. “Active equity managers face many problems beating their index and this would just create another headwind. The average active manager turns over their portfolio three times a year whereas for a passive instrument it is a small fraction of that. You can see that an active fund would have an extra 30 bp to pay before it outperforms.”