Aug 6 (IFR) - A proposed European financial transaction tax
of 0.01% on all derivatives transactions could bring foreign
exchange markets in Europe to their knees, according to Deutsche
The tax, which would also levy a 0.1% charge on share and
bond trades, had originally been scheduled to launch on January
1 2014 before the 11 participating countries decided to delay
implementation for a further six months after concerns it may be
FX market participants will be hoping the FTT is scrapped
altogether, with analysis from Deutsche Bank estimating it could
cost the real economy billions of euros every year.
"In its current form, the FTT would have major adverse
consequences for the FX markets," Oliver Harvey, macro
strategist at Deutsche Bank, wrote in a report.
" could result in the effective closure of the non-spot
FX market in participating member states."
Even though the FTT would exempt spot FX, it would still
have an impact on FX derivatives that corporates, pensions
funds, and insurance companies use to hedge their currency
exposures, including swaps, options, forwards and
non-deliverable forwards. These transactions account for nearly
two-thirds of FX market activity, according to a 2010 survey by
the Bank for International Settlements (BIS).
Those non-financial firms would probably bear the true cost
of the tax, which would make financial intermediation for FX
trades a cost-prohibitive exercise for banks. As and when the
costs of the tax becomes too onerous, banks would most likely
pull back from the market, reducing liquidity and widening
A Deutsche Bank analysis of German export and BIS data
estimated that the FTT would impose annual costs on German
exporters and importers of up to 2.4 billion euros, while German
exports could be reduced by as much as 3.3 billion euros per
"This proposal will have a substantial cost impact on
corporates, given the way they currently hedge their FX risk,"
Deutsche Bank's Harvey told IFR.
"The tax would be passed on straight to non-financials,
irrespective of whether they are exempt, because the spreads
dealers pull from the trades are so much smaller than the tax
UNIQUE FX STRUCTURE
There are a variety of factors explaining why FX
market-making is especially vulnerable to an FTT. Currency
markets maintain an extremely high velocity, with a total daily
turnover in swaps and forwards markets alone of US$2.24 trillion
- over seven times that of all global equity markets.
There is also the short-dated nature of the market: more
than 40% of the FX forwards market is concentrated in tenors of
one week or less, while for swaps it is 70%.
Shorter-dated swaps would be hit harder by the FTT than any
longer-dated transactions. In a report last year, consultancy
Oliver Wyman estimated the FTT would result in a 1,790% price
increase for one-week euro-dollar swaps compared to a 270%
increase for a six-month swap with the same underlying.
The price increases cited by Oliver Wyman actually equate to
a rise in transaction costs corresponding to that witnessed
during the Lehman Brothers liquidity crisis, according to DB
"FX swaps and forwards are rolled over on a daily or weekly
basis by a wide range of market participants in order to meet a
broad range of objectives," said Harvey. "These transactions
would be hit each time by the tax."
Fortunately for FX traders, the FTT proposal has hit a
series of snags since mid-April, when regulators began to throw
up formidable roadblocks in the name of market efficiency.
First, the UK government launched a legal challenge to the
tax at the European Court of Justice in an effort to curb the
extra-territorial effect, since the British government chose not
to participate in the tax but would still be required to collect
when British firms transact in participating countries.
Then in June, the 11 participating countries decided to
delay the planned implementation date, previously January 1
2014, by six months.
"To get to this tax we must be pragmatic and realistic,"
French Finance Minister Pierre Moscovici said last month. "The
European Commission's proposal seems to me to be excessive and
risks being counterproductive."