Death & Taxes on Derivatives? Hopefully Not a Certainty For UK Bankers

The European Commission last week proposed a Financial Transaction Tax (FTT) to potentially levy on all financial instruments between financial institutions transacted in the Eurozone. The tax would range between 0.1% for bonds and stocks and 0.01% of notional of the derivative instrument.  So the FTT on a $100 million notional interest rate swap the tax would be $10,000.  This may not sound like a lot for a 30 year swap, but assuming the same rate regardless of tenor, then it would make short-dated swaps very expensive.  The Commission estimates that the FTT can raise 57 billion Euros annually.

Politically, this is a savvy way to generate revenue as it is positioned as a tax on Swap Dealers who “surely can afford it”.  The individual tax payer is not impacted directly, and making banks pay more won’t lose many votes. 

It’s already rumored to be headed for defeat.  First of all, the tax will not be fair across the Eurozone where financial centers like London will carry as much as 80% of the tax.  Banks would be seen fleeing Canary Wharf for FTT free waters, along with jobs and real estate values.  Non-Eurozone countries would seize the opportunity to boost its own economies by offering a safe haven.  Taxes generated in London would not go the UK government but to the ECB.  Fortunately for European banks and London residents, a unanimous vote is required to pass the tax.  Surely the UK could never vote for such a bill, despite the temptation to make a statement against the banks.

In addition to the potential economic damage to London and other Eurozone financial centers, more than likely the FTT will be passed on indirectly to the swap counterparties as yet another cost to bear on top of the many heading their way due to financial regulation.  Although the tax is not imposed on instruments not executed with a bank, if a bank has to offset a risk position on a derivative sold to a client, then it would have to include this tax on its ultimate cost to do business.

As profitable as trading can be (or used to be) for banks, 57 billion Euro would be a big chunk to take out of bank profitability.  Banks are laying off tens of thousands of people, not all highly paid traders, but bank tellers, clerks and other middle class working people.  Bank share prices continue to be crushed.  Taxation, however politically tempting, is not the answer to stimulate growth and create jobs, unless you want to create jobs in Hong Kong or Singapore or potentially in the U.S., assuming the I.R.S. doesn’t follow suit.