The EU’s financial tax proposals will affect every single investor across Europe, pushing up the cost of funds and hampering what instru-ments portfolios look to hold.
The planned financial transaction tax is aimed at making financial firms, which are purported to have caused the current economic problems in the first place, pay. Among the reasons cited for the proposal was “to ensure that financial institutions make a fair contribution to covering the costs of the recent crisis”. That intention may be good but it will be the ordinary investor that pays – and so too will their advisers – not the investment banks.
The FTT would in effect work the same as the UK’s existing stamp duty, which funds must pay on the purchase of any UK equities. While stamp duty is levied on purchases of UK equities at 0.5 per cent, typically it is diluted within funds and amounts to around five basis points in additional charges. The good news is that under FTT, stamp duty would go. The bad news is the FTT affects far more assets than stamp duty ever did, is twice the effective rate and is applicable on both purchases and sales.
In addition, it hits every link of the sales chain so cumulatively the end investor would end up paying it more than once. They could even end up paying it more than twice – potentially as much as five different times in a single fund investment.
IMA director Julie Patterson says: “This is going to be an absolute nightmare. This is so obviously a direct tax on the investor because it goes right down the chain and the investment banks, who it is intended to affect, can offload their tax hit immediately in increased commission or spreads.”
Under FTT, transactions in equities, bonds and money market instruments would cost 10 basis points per transaction while derivatives cost just one basis point. Physical property and private equity would be outside the scope.
The FTT covers all collective investment schemes, including pensions. While the end investor does not directly pay the tax, as they are not deemed a financial institution, those who arrange a purchase on their behalf would be.
Patterson says this potentially means every adviser, regardless of whether or not they hold client money, would pay the transaction tax (a percentage of the value being traded) every time they instruct the buying or selling of units in a fund.
If the adviser uses a platform, it too would have to pay the tax on that same transaction. Then the fund itself has to pay for any purchase or sale of its underlying holdings, the investment manager acting on behalf of the fund will pay it and so too will the wholesale broker they instruct to place the trade with the investment bank. All these different parties are not sharing the one transaction tax – instead each has to pay it separately. No wonder the EU estimates it could generate €57bn in annual revenues.
If all that is not complicated enough, along come the exemptions. Transactions via central banks will be left outside the FTT but so too will insurance products. This means savers in funds would be hit but not those buying a unit-linked policy or with-profits product.
Patterson says while structured products would be hit, structured deposits would not.
As physical property is not traded on the market, it too is exempt. However, Patterson comments that the buying or selling of units of funds holding physical property will be caught. This means an IFA would have to pay the tax for introducing a client to a property fund, even if the fund itself does not suffer the tax.
Property portfolios are unlikely to get away entirely unscathed. Bricks and mortar funds have liquidity buffers and instead of holding this in low-yielding cash, they opt for money market instruments. Patterson questions how likely they would continue to do so with the 10 basis point tax attached to such investments.
With a lower FTT on derivatives, managers in ordinary equity or bond portfolios could also opt for a cheaper way to gain exposure to a stock, which in turn would fundamentally change what an investor is buying.
Operationally, such a system could have additional cost pressures for companies, which in turn will affect the cost of funds. The EU is proposing countries be ready to implement this on January 1, 2014. Already, most groups have to contend with system changes and the admin necessities to contend with forthcoming domestic regulation changes such as the RDR, let alone other EU initia-tives such as the AIFMD and Mifid.
The one saving grace in what looks to be a nightmare scenario for Euro-pean investors is that the FTT needs unanimous approval. Any country can veto this, Patterson explains. However, there are several reasons why they may not, not the least of which has been the public clamour for financial institutions to feel some of the pain the crisis has wrought.
Although it seems likely the UK will exercise a veto in this case, it is not a foregone conclusion. The UK government has already indicated it would consider the FTT if it were a global proposal and that possibility is very real. In the EU’s September 28 proposals, it made mention that global implem-entation is in discussions. The EU stated: “In order to best minimise risks, a co-ordinated approach at international level is the best option. The present proposal demonstrates how an effective FTT can be designed and implemented, generating signi-ficant revenue. This should pave the way towards a co-ordinated approach with the most relevant international partners.”
Politicians could be led to appro-ving the plan, as public perception may be that this proposal is a step in the right direction in making financial institutions pay. In reality, it will be ordinary investors who feel the pain and it will once again be left to advisers to explain why invest-ments are becoming more expensive at a time when everyone keeps saying they need to invest.