(May 20, 2013) -- The Association for Financial Markets in Europe (AFME) has produced further evidence that the European Commission's proposed Financial Transaction Tax (FTT) will damage pension funds.
A report commissioned by the lobbying group, and carried out by Oxera, has criticised the European Commission (EC) for failing to recognize the extent to which the FTT will hit global pension funds.
By the EC's own estimates, final salary pension funds which are actively managed could lose as much as 8% of their value as a direct result of the tax.
Despite this, the EC claims the impact of the FTT would be "limited," assuming pension funds will take mitigating action such as reducing their trading activities and reducing derivative contracts - all of which the EC assumes will be done at a neutral cost.
The EC also presumes pension funds would benefit from the reduction in activities by financial intermediaries as it would lead to lower transaction costs, but as Oxera points out, is extremely unlikely to happen as the FTT will lead to lower liquidity, and that increases transaction costs.
"The Commission's illustrations of the impact on pension funds present a relatively severe impact for an illustrative actively managed fund; the impact of the FTT accumulates significantly over time," Oxera wrote.
"The FTT would therefore further undermine the confidence of savers in making long-term provisions for retirement… the impact would vary across different pension products, and potentially encourage funds to shift to untaxed investments, which may or may not be in the interests of consumers."
Oxera also criticised the EC for underestimating the impact the FTT would have on derivatives markets - which pension funds use regularly as part of their derisking strategies.
The EC's FTT's scope will include derivatives as it aims to include as many types of financial transaction as possible, but this puts it at odds with existing FTTs in Italy, Hungary and France which do not include derivatives.
The EC believes two-thirds of its €34 billion estimated revenue from the tax will come from derivatives, even if 75% of today's derivatives trades are ceased, as it predicts.
Oxera believes certain transactions will be hit harder than others, including those used predominantly by pension funds.
Derivatives used to provide minimum guarantees, including those which involve options to sell assets at prices significantly lower than the current market price.
These have a much higher notional value than economic value, as the option will only be exercised if there is an unexpectedly large decline in prices - meaning the FTT applied to these options would make them prohibitively expensive and could discourage this form of derisking.
The third reason given for the EC to reassess the impact of the FTT was the likelihood of brokers being used to act as agents for end-users.
Under the current proposals brokers will be allowed to facilitate trades between end-users without incurring the tax, but the EC has failed to look at the costs this will put on those customers and the increased counterparty risk this will cause.
Finally, Oxera notes the FTT will have a damaging impact on the cost of secondary trading in government debt.
Further research is needed into the impact of the FTT on transaction prices on government funding costs, and the potential knock-on effect for the wider economy.
The EC expects the FTT to raise €6.5 billion from taxing government bond transactions for the 11 member states participating in enhanced cooperation, which are Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia, and Slovakia.
The cost of funding government debt would be increased due to the need for increased yields to compensate investors for the FTT cost - and the EC estimated that increase would total 0.07%, raising debt funding costs by €4 billion.
This €4 billion would almost wipe out the €6.5 billion the EC plans to raise, Oxera points out. The EC has also potentially underestimated what this tax would do to the volume of bond trades - current estimates suggest a 31% decrease according to the Commission, but Oxera believes that figure could be "much greater".
ATP, one of Europe's biggest pension funds, told aiCIO last month it was considering using more derivatives to keep the fund's tax bill down, as well as investing in countries unaffected by the FTT. It remains to be seen how other pension funds will react.
Related News: The Deafening Silence on FTTs and ATP Decries Financial Transaction Tax