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European Repo Representatives Call For FTT Exemptions

by Ulrika Lomas,, Brussels

10 April 2013

The repo market is likely to experience a severe contraction if the European Commission fails to exclude it from the proposed financial transactions tax (FTT), the International Capital Markets Association (ICMA) has claimed.

Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia are progressing with plans for an FTT along the lines of "enhanced cooperation." This procedure, which enables those states wishing to work more closely together to do so, was authorized by the European Council of Economic and Financial Affairs (Ecofin) in January. Under the European Commission's plans, all share and bond transactions will be taxed at a rate of 0.1%, and derivatives transactions at 0.01%. The tax is intended to apply from from January, 2014.

The flat 0.1% rate will be applied regardless of the length of term of the repo, and the FTT is expected to cover approximately 66% of the European market. A new study commissioned by ICMA's European Repo Council warns that this will make repo trading for terms of less than 12 months (and possibly longer) economically unviable. The result would be a contraction of the short-term repo market by at least 66%, while what remained "would, at best, be a customized high-cost rump."

The loss of repo and the lack of an alternative secured trading instrument is anticipated to have serious knock-on effects. The report states: "The destruction of the market in repo and money market securities by the flat rate of taxation would force institutional and corporate investors back into the unsecured deposit market, probably at the overnight end and in banks considered 'too big to fail,' making the financial system more vulnerable to runs, increasing the moral hazard faced by the authorities and ramping up systemic risk by unraveling the process of collateralization that has become a central policy in the evolving global regulatory framework being driven by the G20 and the Basel regime."

Banks would be unable to borrow with ease from institutional investors or manage their liquidity in the interbank market. This would in turn impact on the capacity of banks to lend to industry, while the absence of an efficient repo market able to underpin primary and secondary debt market activities would hit those financial institutions and firms trying to raise capital. The overall result would be to place financial institutions, businesses and governments in the FTT countries at a competitive disadvantage.

There is likewise "a real risk of capital flight from the EU11 by institutional and corporate investors, using the untaxed escape route to banks outside the EU11 provided by deposits." The report warns that this "would cause liquidity problems inside the EU11 and drive fault lines across the monetary landscape of the eurozone between the EU11 and the rest of the zone, with operational implications for the implementation of monetary policy." The integrity of the Single European Market would also thereby be undermined.

In a broader European context, the report envisages a "spill over into the rest of the EU through the taxation of EU11 investors buying non-EU11 securities and non-EU11 parties trading or investing in the EU11 or on EU11 markets. This is likely to generate political and legal frictions, which would be exacerbated by aggressive resort cross border to anti-avoidance measures."

At a more global level, initiatives such as the Basel regime and the requirement that financial transactions be collateralized, would be adversely affected. System operational risk would be exacerbated because the means of borrowing securities to prevent delivery failures would be removed, and the infrastructure that supports the efficiency of collateral management would cease to be viable.

Godfried De Vidts, Chair of ICMA's European Repo Council said: "Repo transactions fulfill a crucial role in financing the economy and are an increasingly important part of the regulatory landscape as a result of the Basel requirements moving financial institutions towards secured lending. Harming the efficient operation of this market by the imposition of a financial transaction tax would jeopardize central bank monetary implementation and be at odds with the various steps taken by the ECB to safeguard the single currency."

The report calls for secured financing transactions such as repo and securities lending to be exempted from the FTT, along with primary dealers and market-makers in fixed-income securities markets. It stresses that as the FTT is unlikely to be abandoned, the "only realistic strategy is to spell out the implications of the current FTT proposal for public finances, monetary policy, financial stability and economic policy to those responsible for these policy areas, and seek to have the FTT recast as a purely fiscal instrument and not a tool for restructuring the financial market."

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