Release Date: 17 January 2012
Contact: James White, 201.962.7390, 

EU’s Financial Transaction Tax could increase FX costs by 9 to 18 times for Europe’s pension funds and businesses 

A Financial
Transaction Tax (FTT) levied across the European Union would seriously impact
the foreign exchange market, increasing transaction costs by up to 18 times,
according to Oliver Wyman research commissioned by GFMA’s Global FX Division. 

The report
findings suggest that, given the tight margins that exist in foreign exchange
markets, this increase would, in turn, hit the real economy as these costs would
largely be passed onto all end-users, such as Europe’s financial institutions,
(pension funds, asset managers, insurers) and corporates.  

The global
foreign exchange market is the most liquid in the world, with an average daily
turnover of $4 trillion, according to the Bank for International Settlements,
and is used extensively by corporates, as well as investors.  The majority of FX trading volume (45%) takes
place in the FX swaps market. 

The report, ‘Proposed EU Commission Financial
Transaction Tax; Impact Analysis of Foreign Exchange Markets’
, evaluates
the impact of the European Union’s proposed FTT on European FX markets,
estimating its impact on FX cash and derivatives users. The report not only
recognises a primary impact of the
tax – an increase in transaction costs, relocation of trading and reduction in
notional turnover – but also a secondary
impact, namely, a potential reduction in liquidity leading to a widening of
bid/ask spreads.   The research suggests that a proposed FTT would:

  • Directly increase transaction costs for all transactions by three
    to seven times and by up to 18 times for the most traded part of the market;
  • Potentially relocate 70-75% of tax eligible transactions outside
    of the EU tax jurisdiction; combined with reduced transaction volumes (of
    approx 5%), this could reduce market liquidity and increase indirect
    transaction costs by up to a further 110%;
  • Predominantly hit the real economy (pension funds, asset managers,
    insurers and corporates) as both direct and indirect costs are largely passed
    onto end-users, who will be least able to move transactions to jurisdictions
    not subject to the tax;
  • Have a limited impact on speculative trading as this activity will
    most likely relocate outside the EU tax jurisdiction;
  • Inefficiently tax the economy as raising €1 of tax would likely
    cost the economy more than €1, due to the indirect costs associated with
    reduced and more fragmented liquidity. 

To reach this increase
of 18 times, the report used the example of the most liquid swap product – the
EUR/USD 1 week swap with a notional value of €25,000,000, as transacted between
a bank and a financial institution (e.g. pension fund). The current cost to
transact for the end-user is €279.  The
additional taxation of this transaction at 0.01% is €2,500 to the dealer and an
additional €2,500 to the financial institution, resulting in a total cost of
€5,279 or an 18-fold increase, assuming all costs are passed onto users. (FX
swaps with maturity of less than one week account for over 50% of the tax
eligible FX cash and derivatives market).

James Kemp,
managing director of GFMA’s Global FX Division commented:

“It is essential
to fully understand the impact of the proposed financial transaction tax and
the Oliver Wyman study is an important contribution to the debate.

“The foreign exchange industry is an
essential part of a stable and sustainable economy, underpinning international
trade and investing.  This study shows
that the proposed tax would in effect penalise Europe’s businesses for sensible
risk management – by using FX products to manage currency fluctuations – and
also threaten to impose further costs on the investment returns of pension
funds and asset managers.

“In addition, the combination of direct
costs and indirect costs, arising from reduced market liquidity and wider
bid/ask spreads, means that raising €1 in tax is likely to cost users more than
the amount of the tax itself.”  

For the full report, click here.