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LONDON, March 11 (Reuters) - The European Union's planned financial trading tax could strangle the region's secured funding market just as it recovers from the financial crisis, an industry official warned on Monday.
The proposal to tax transactions in the repo market, where banks commonly use government bonds as collateral to raise funds, could also squeeze funding to the rest of the economy, Godfried de Vidts, Chairman of the International Capital Market Association's European Repo Council said.
"The market liquidity will dry up totally because the cost is so prohibitive that people will not do repo transactions with each other. The repo market will cease to exist," de Vidts told Reuters by telephone from Paris.
The Repo Council, which represents major banks active in the market, wants repo transactions to be exempted from the tax and was discussing the issue at its annual general meeting in Paris on Monday before taking it up with European Union authorities, de Vidts said.
The trading tax, intended to make banks pay for aid they received in the financial crisis, would be set at 0.01 percent for derivatives and 0.1 percent for stocks and bonds and aims to raise 30-35 billion euros annually.
It has already been approved by 11 European Union countries, including Germany and France. Further approvals are needed in the EU before it can take effect.
Gabriele Frediani, head of electronic trading platform MTS, urged a rethink of the tax at a conference last week, saying that the European repo market could shrink by 99 percent if the proposal was adopted. "The repo market will disappear," he said.
According to the latest ICMA survey, the European Central Bank's 1 trillion euros of cheap three-year funds continued to stifle repo market activity towards the end of last year.
The twice-yearly survey showed the amount of business outstanding in the market fell to 5.611 trillion euros by Dec. 12 from 5.647 trillion in June 2012. The survey was conducted before European banks began making early repayments of the ECB's three-year funds on Jan. 30.
Repo deals reached a high of 6.204 trillion in December 2011 and a low of 4.633 trillion reached in December 2008, at the height of the financial crisis which froze interbank lending.
The survey showed a rise in German and French government bonds used as collateral as investors stopped hoarding higher-rated assets, after an offer by the ECB to buy bonds of struggling states who ask for aid improved sentiment in euro zone markets.
The use of bonds issued by Italy, one of the countries at the forefront of the euro zone debt crisis, edged up to 8.7 percent from 8.3 percent in June 2012 while that for fellow straggler Spain slipped to 4.9 percent from 5.0 percent.