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The European Commission has already explicitly excluded FX spot transactions from the scope of any tax. However, as the GFXD points out, imposing an FTT on other FX products heavily traded by these users – specifically FX forwards, swaps, options and NDFs – risks discouraging companies and investors from international trade and investing. If they continue with international activities, then the impact will be to either see them reduce the hedging of their international activities – with the resultant increase in earnings volatility and business risk – or to take on the additional tax costs that they could otherwise have directed to growth or to delivering fund returns for investors.
Corporates using FX
Businesses involved in international trade often have multiple income and payment streams in different currencies as they export and import goods and raw materials. Access to cost effective hedging and funding – through these FX products – allows them to trade internationally with certainty on their FX exposures.
By imposing an FTT, these European corporates will see their FX transaction costs rise by up to 700 per cent. For example, with just a single dealer, a business based in the tax zone could see its annual FX transaction costs rise from €1.8 million to €15.7 million per year. The tax creates a disincentive for international trade, investment and growth.
Pension funds using FX
A pension fund manager investing globally has multiple cash flows in different currencies on various pension portfolios. The fund manager needs to be able to convert all these currency flows into a single balance on a weekly basis, undertaking FX transactions to meet liabilities in different currencies. These pension fund investors benefit from access to a cost-effective FX swaps market.
For a pension fund manager, the FTT impact is compounded due to the double sided nature of the proposed tax and these users could see transaction costs rise by around 1,500 per cent and possibly by as much as 4,700 per cent. A pension fund manager used to annual transaction tax costs (via a single dealer) of €1.2 million, could see transaction costs caused by the FTT exceed €57.6 million. These costs will be passed onto investors in the form of poorer investment returns.
It is worth noting that in 2011, the European Commission recognised that including FX spot transactions in the FTT would infringe the movement of capital under the Treaty for the Functioning of the European Union and it also raised concerns about including other FX products.
Commenting on the impact assessment of the proposed transaction tax, James Kemp, managing director of the Global Financial Markets Association’s Global FX Division, said: “The FX market is highly transparent, highly liquid and underpins international commerce and investment by providing corporates and fund managers with an efficient way of carrying out their business. Given the need for Europe to kick-start economic growth, it is crucial to ensure that European companies of all sizes are able to compete internationally. FX products are central to their ability to do this. In addition, the proposed tax risks becoming a disincentive for businesses to hedge risk which could increase their earnings volatility and business risk. The effect of the proposed tax on pension funds is even worse than on corporates, as it will be taxed on both sides. The result will be reduced fund performance to the detriment of institutional and individual investors.“