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August 4, 2013 5:22 am
Europe’s proposed financial transaction tax is causing more than a little consternation among those with any involvement in the continent’s securities lending industry.
The mooted tax will wipe out 65 per cent of lending activity in Europe. It will slash the €3bn a year of windfall revenues earned by long-term asset owners such as pension funds and mutual funds by more than €2bn, according to the International Securities Lending Association (Isla), a trade association.
Dominique Carrel-Billiard, the outgoing chief executive of Axa Investment Managers, went further still last month, telling Global Investor magazine that the FTT would “completely wipe out securities lending” if implemented in its proposed form.
The proposed FTT is designed to discourage “excessive” short-term trading. It will try to achieve this by throwing grit into the wheels of finance in the shape of a tax of 0.1 per cent on the trading of equities and bonds, and a 0.01 per cent levy on derivatives. Some politicians also view it as a way to force banks to help pay the costs of the financial crisis.
Eleven eurozone countries, including France and Germany, currently aim to introduce the tax, although horse-trading is continuing over possible exemptions for pensions funds or the trading of sovereign bonds, small company stocks and some derivatives.
However, as things stand, Kevin McNulty, chief executive of Isla, says the FTT “would effectively close down” the securities lending markets in the 11 countries.
The typical securities lending transaction has generated 18 basis points of return in the past year, he says, citing data from Markit Securities Finance. This figure would be more than erased by an FTT of 20bp (based on the borrower paying the tax when they buy the security, then the beneficial owner paying to buy it back at a later date).
Mr McNulty estimates that only the 35 per cent most profitable trades would remain viable in the 11 participating states, and that securities lending fees would need to rise by more than 400 per cent to maintain current revenue levels for the asset owners that lend out their holdings.
He foresees other side effects too. Without ready access to a thriving securities lending sector, market makers have to widen their bid-offer spreads to cover their increased market risk. Almost €500bn of eurozone government bonds would be removed from the lending market, reducing the quantity of high-quality collateral available to back derivatives trades and other transactions. The lack of available inventory would increase the risk of “settlement fails” by as much as 100 per cent, increasing systemic risk.
Don D’Eramo, senior managing director for securities finance in Europe, the Middle East and Africa at State Street, argues that any Europe-wide FTT should replicate similar domestic taxes in France and Italy that include exemptions for securities lending, as well as for repo transactions.
“Lending has always been regarded as something that adds liquidity and is efficient from a market pricing perspective,” says Mr D’Eramo. “It allows long-only mutual funds and pension plans to gain revenues, and market transactions to be done more efficiently.”
The push for a European FTT comes at a difficult time for the securities lending industry. New tax harmonisation rules in France, which force domestic funds to pay the same rate of dividend tax as foreign funds holding French equities, are likely to reduce the demand for stock lending for dividend “washing” trades.
These arbitrage strategies, which account for 80 per cent of European stock lending revenues, according to BNP Paribas Securities Services, may also be under threat in countries such as Germany, Spain, Belgium and Poland if they are forced to follow France’s lead.
Sven Giegold, a German Green MEP who is among those pushing for a European FTT, is more relaxed about the potential repercussions.
“I always admire people who can predict the future, I would love to be able to,” he says of Isla’s forecast of a 65 per cent fall in lending activity.
Mr Giegold does accept that the introduction of an FTT would reduce lending volumes, and by implication revenues for asset owners. However, he believes a broader reduction in short-term trading activity resulting from an FTT would reduce systemic risk, benefiting long-term asset owners and more than making up for any loss in lending revenues.
“Securities lending, if it is short term, will go down, that’s a natural consequence of an FTT, but from a macro perspective I’m not that interested,” says Mr Giegold candidly.
“Certain business models will shrink, how much by is unclear. I doubt whether that matters. For people working in the sector I understand why this matters. But financial markets are too short-termist.”
Mr Giegold is opposed to any exemptions being granted, even for pension funds, in order to maintain fair competition. He says those who argue for exemptions for market makers “can’t define the difference between market-making and proprietary trading”. Moreover, he is unconcerned about any potential widening of bid-offer spreads.
“Will the world die from that? Will the whole money business die? No. All this does not make me very nervous.”
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